The Organization
5
Chapter Outline
5-1 Organizational Direction: Mission, Goals, and Objectives
W
I 5-1a Global Influences on Mission
L 5-1b Goals and Stakeholders
5-2 Social Responsibility
S
5-3 Managerial Ethics
O5-4 The Agency Problem
N 5-4a Management Serves Its Own Interests
, 5-4b Management and Stockholders Share the Same Interests
5-5 Corporate Governance and Goals of Boards of Directors
J5-6 Takeovers
5-7 Summary
A
Key Terms
MReview Questions and Exercises
I Practice Quiz
ENotes
Reading 5-1
5
0
5
1
B
U
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
94
Chapter 5
W
hereas previous chapters discussed the external analysis phase of
the strategic management process, this chapter begins to consider
internal factors. This shift from the industry level to the organizational level reflects a change in focus from similarities, or factors
that tend to affect all of an industry’s organizations in a like manner, to differences, or issues specific to a particular firm in an industry. This shift also relates
to theoretical perspectives discussed in Chapter 1, marking a movement from an
industrial organization (IO) perspective to a resource-based view of the firm.
Crafting a strategy for an organization whose purpose and resources are not
well understood by its members is a difficult task, however. This chapter discusses
the role that an organization’s unique mission and resources, as well as social
responsibility and ethics, play in the strategic management process.
5-1 Organizational Direction: Mission,
Goals, and
W Objectives
Mission
The reason for an
organization’s existence.
The mission statement
is a broadly defined but
enduring statement of
purpose that identifies
the scope of an organization’s operations and
its offerings to the various stakeholders.
Goals
Desired general ends
toward which efforts are
directed.
Objectives
Specific, verifiable, and
often quantified versions
of a goal.
Comparative
Advantage
The idea that certain
products may be produced more cheaply or
at a higher quality
in particular countries,
due to advantages
in labor costs or
technology
Several terms are commonly
used to delineate the direction of the organizaI
tion. The mission is the reason for the firm’s existence and is the broadest of
L
these terms. The organization’s goals represent the desired general ends toward
S Objectives are specific and often quantified versions
which efforts are directed.
of goals. Unlike goals, O
objectives are verifiable and specific, and are developed so
that management can measure performance. Without verifiability and specificity,
N a clear direction for strategy.
objectives will not provide
For example, the mission
of an Internet Service Provider (ISP) might be “to
,
provide high-quality, reliable Internet access to the southeastern United States
at a profit.” Management may establish a goal “to expand the size of the firm
through acquisition ofJ small ISPs.” From this goal, specific objectives may be
derived, such as “to increase access numbers by 20 percent each year for the next
five years.” As anotherA
example, management’s goal may be “to be known as the
innovative leader in the
Mindustry.” On the basis of this goal, one of the specific
objectives may be “to have 30 percent of sales each year come from new products
developed during the Ipreceding three years.”
E
5-1a Global Influences on Mission
An organization’s mission
5 may be closely intertwined with international operations in several ways. A firm may need inputs from abroad or sell a large percentage of its products to 0
global customers. Consider, for example, that virtually all
of Japan’s industries would
5 grind to a halt if imports of raw materials from other
nations ceased, because Japan is a small island nation and its natural resources
1
are quite limited.
Organizational mission
B and international involvement are also connected
through the economic concept of comparative advantage, the idea that certain
U more cheaply or at a higher quality in particular
products may be produced
countries due to advantages in labor costs or technology. Chinese manufacturers, for example, have enjoyed some of the lowest global labor rates for unskilled
or semiskilled production in recent years. As skills rise in the rapidly emerging
nation, some companies have succeeded in extending this comparative advantage to technical skill areas as well. The annual salary for successful engineers in
China rose to around $15,000 in 2007, a level well below their comparably skilled
counterparts in other parts of the world.1
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
Global involvement may also provide advantages to the firm not directly related
to costs. For political reasons, a firm often needs to establish operations in other
countries, especially if a substantial proportion of sales is derived abroad. Doing
so can also provide managers with a critical understanding of local markets. For
example, Ford operates plants in western Europe, where manufacturing has
helped Ford’s engineers design windshield wipers for cars engaged in high-speed
driving on the German autobahns.2
95
Source: Ablestock.com
5-1b Goals and Stakeholders
At first glance, establishing a mission, goals, and objectives for a firm appears
to be fairly simple; however, because stakeholders have different perspectives
on the purpose of the firm, this task can become quite complex. Stakeholders
are individuals or groups who are affected by or can influence an organization’s operations. Firm stakeholders include such groups as shareholders,
members of the board of directors, managers, employees, suppliers, creditors,
and customers (see Table 5-1). As owners, shareholders traditionally represent
W
the dominant group of stakeholders. Top managers, too, should be concerned
I objective of profits, but also with
not only with the shareholders’ primary
those of other stakeholders.3 Ideally, theLmission, goals, and objectives should
emphasize goals of the shareholders, and balance the pressures from other
S
stakeholders.4
It is not difficult to see how stakeholder O
goals can conflict with one another. For
example, shareholders are generally interested in maximum profitability, whereas
N survival so that their loans will be
creditors are more concerned with long-term
repaid. Meanwhile, customers desire the ,lowest possible prices, even if offering
them would result in losses for the firm. Hence, top management faces the difficult
task of attempting to reconcile these differences while pursuing its own set of goals,
which typically includes quality of work lifeJand career advancement.
TA B L E
5-1
S ugges ted Go a ls o f
Goals
Customers
The company should provide high-quality products and services at the most reasonable prices possible.
The company should5provide goods and services with minimum environmental costs, increase employment opportuni0 social and charitable causes.
ties, and contribute to
The company should5establish long-term relationships with
suppliers and purchase from them at prices that allow the
suppliers to remain profi
1 table.
The company should provide good working conditions, equitable compensation,B
and opportunities for advancement.
The company shouldU
maintain a healthy financial posture and
a policy of on-time payment of debt.
The company should produce a higher-than-average return on
equity.
Current directors should be retained and shielded from a legal
liability.
The company should allow managers to benefit financially
from the growth and success of the company.
Suppliers
Employees
Creditors
Shareholders
Board of directors
Managers
Individuals or groups
who are affected by or
can influence an organization’s operations.
A
S tM
a k eh o ld er s
I
E
Stakeholders
General public
Stakeholders
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
96
Chapter 5
This balancing act is evident when one considers the clash that can occur
when top management goals are pitted against those of the board of directors.
Although both groups are primarily accountable to the owners of the corporation, top management is responsible for generating financial returns and the
board of directors is charged with oversight of the firm’s management. Some have
argued, however, that this traditional shareholder-driven perspective is too narrow,
and that financial returns are actually maximized when a customer-driven perspective is adopted, a view that is consistent with the marketing concept.5 Consumer
advocate and 2000 U.S. presidential candidate Ralph Nader has argued for more
than thirty years that large corporations must be more responsive to customers’
needs.6
Firms create value for various parties, including employees through wages and
salaries, shareholders through profits, customers through value derived from
goods and services, and even governments through taxes. Firms that seek to
maximize the value delivered to any single stakeholder at the expense of those
of other groups can jeopardize their long-term survival and profitability.7 For
example, a firm that emphasizes
the financial interests of shareholders over the
W
monetary needs of employees can alienate employees, threatening shareholder
I Likewise, establishing long-term relationships with
returns in the long run.
suppliers may restrict L
the firm’s ability to remain flexible and offer innovative
products to customers. Top management is charged with the task of resolving
opposing stakeholder S
demands, recognizing that the firm must be managed to
balance the demands of
O various stakeholder groups for the long-term benefit of
the corporation as a whole.8
5-2 Social
Social Responsibility
The expectation that
business firms should
serve both society and
the financial interests of
shareholders.
N
,
Responsibility
An organization’s direction is governed in part by its value system. An organization’s values can be seen
J through its stance on service to society, as well as its support for high ethical standards among its managers. These factors are discussed
A
in this section.
Social responsibilityM
refers to the expectation that business firms should serve
both society and the financial interests of the shareholders. A firm’s stance on
I
social responsibility can be a critical factor in making strategic decisions. If social
E
responsibility is not considered,
decisions may be aimed only at profit or other
narrow objectives without concern for balancing social objectives that the firm
might embody. The degree to which social responsibility is relevant in strategic
5 debated, however.
decision making is widely
From an economic0perspective, businesses have always been expected to
provide employment for individuals and meet consumer needs within legal
5
constraints. Today, however,
society also expects firms to help preserve the
environment, to sell safe
products,
to treat their employees equitably, and to
1
be truthful with their customers.9 In some cases, firms are even expected to
B
provide training to unemployed
workers, contribute to education and the arts,
and help revitalize urban
areas.
Firms
such as Home Depot, Coca-Cola, UPS, and
U
Johnson & Johnson recently earned high marks for social responsibility, whereas
Bridgestone and Philip Morris were at the bottom of the list.10 Figure 5-1 illustrates
the approach to social responsibility at Johnson & Johnson, a firm whose corporate reputation ranked number one in 2002 and 2003 in the Harris Interactive
survey.11
Many economists, including such notables as Adam Smith and Milton Friedman,
have argued that social responsibility should not be part of management’s
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
FIGURE
5-1
J ohns on & J ohns on Credo
W
I
L
S
O
N
,
J
A
M
I
E
5
0
Source: Reprinted by permission of Johnson & 5
Johnson
1
B
U
decision-making process. Friedman has maintained that business functions best
when it concentrates on maximizing returns by producing goods and services
within society’s legal restrictions. According to Friedman, corporations should
be concerned only with the legal pursuit of profit, while shareholders are free
to pursue other worthy goals as they individually see fit. Even if one accepts
Friedman’s argument, firms should act in a socially responsible manner for two
primary reasons.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
97
98
Chapter 5
Source: Ablestock.com
Source: Ablestock.com
First, acting responsibly can reduce the likelihood of more costly government
regulation. Historically, regulations over business operations often were enacted
because certain firms refused to act responsibly. Had some organizations not
damaged the environment, sold unsafe products, or engaged in discrimination
or misleading advertising, legislation in these areas would not have been necessary. Government regulation is always possible when companies operate in a
manner contrary to society’s interests, even if doing so is clearly within the legal
jurisdiction of the firm.
Second, stakeholders affected by a firm’s social responsibility stance—most
notably customers—are also those who must choose whether to transact business
with the firm. Prospective customers have become more interested in learning
about a company’s social and philanthropic activities before making purchase
decisions. Those who believe a firm is not socially responsible may take their business elsewhere. The social responsibility debate aside, many executives—especially those in large firms—have concluded that their organizations must at the
minimum appear to be socially responsible or face the wrath of angry consumers.
As such, they are greatly
W concerned about both the actual behavior of the firm
and how it is perceived. Evidence suggests that consumers want the firms that
produce the products Iand services they buy not only to support public initiatives,
but also to uphold the L
same values in terms of the day-to-day decisions of running
the company.12 By definition, a firm that is socially responsible is one that is able
S
to generate both profits and societal benefits; but exactly what is good for society
13
is not always clear. For
O example, society’s demands for high employment and
the production of desired goods and services must be balanced against the polN
lution and industrial wastes that may be generated by manufacturing operations.
The decisions made to,balance these concerns, however, can be quite difficult to
make (see Strategy at Work 5-1).
Social responsibility is a prominent issue in some industries. Pharmaceutical
J spend billions of dollars to develop drugs for treating
manufacturers, for example,
a wide range of ailments.
AThe costs of the drugs, however, can determine the extent
to which patients will benefit from them. In the United Kingdom, government offiMto stop prescribing various drugs for Alzheimer’s disease,
cials called on physicians
acknowledging their benefi
I ts but arguing that they do not justify the cost.14 The same
E
S T R A T E G Y
A T
W O R K
5 - 1
GMAbility: Social5Responsibility in Action
The public emphasis that General Motors places0on
social responsibility is quite noteworthy. The company’s
5
“GMAbility” initiative (www.gm.com/company/gmabil1
ity) highlights a number of GM activities. For example, according to its 2001 sustainability report, B
GM
has taken action to reduce emissions and water and
U
energy consumption, while increasing its community
support and number of partnerships. GM is also active
in a variety of recycling, education, hazardous waste
collection, and pollution prevention programs.
GM has partnered with The Nature Conservancy, an
international environmental organization. GM spends
$1 million annually to assist in the preservation of land
and water systems in North America, Latin America,
the Caribbean, and the Asia/Pacific region.
GM also participates in a variety of philanthropic
activities, such as violence reduction programs in
schools, Special Olympics, and community development.
For example, GM partnered with Sun Microsystems
and EDS to contribute more than $211 million in computer-aided design, manufacturing, and engineering
(CAD/CAM/CAE) software, hardware, and training to
Virginia Tech.
Sources: R. Alsop, “Perils of Corporate Philanthropy,” Wall Street
Journal, 16 January 2002, B1, B4; General Motors, www.gm.com/
company/gmability, accessed March 14, 2002.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
realities can be true for medical procedures, especially in emerging economies. The
pay-as-you-go system for medical treatment in China ultimately can deny costly lifesaving treatment for the majority of its citizens who lack health insurance.15
In some instances, society’s expectations of an organization may increase as
the firm grows. For example, various constituencies have charged Wal-Mart with
socially irresponsible behavior in recent years. Critics allege that the mega-retailer
often competes unfairly, does not always follow fair hiring and promotion practices, and even contributes to local economic problems by abandoning strip-mall
locations when larger stores are constructed. In 2004, CEO Lee Scott signaled a
more assertive approach to countering such claims. As Scott put it, “When we’re
wrong, we change, so our detractors don’t have a foothold in attacking us. Where
we are right, we will fight and take each issue to the wall.”16
A broader notion of social responsibility, sustainable strategic management
(SSM), has received increased attention in recent years. SSM refers to the strategies and related activities that promote superior performance from both market
and environmental perspectives. Hence, an ideal strategy should seek market
sustainability by meeting buyer demandsW
and environmental sustainability by
proactively managing finite resources. Organizations able to meet this challenge
are more likely to perform well and benefiI t society over the long term.
L
5-3 Managerial Ethics
S
Although social responsibility and managerial
O ethics are often grouped together
in the popular business press, the terms are not synonymous. Whereas social
responsibility considers the firm’s ability N
to address issues beyond the financial
concerns of the shareholders, managerial,ethics refers to an individual’s respon-
sibility to make business decisions that are legal, honest, moral, and fair. Strategic
decisions should not require managers or other employees to perform activities
inconsistent with their ethical convictionsJconcerning the role that they may be
expected to play in firm activities (see Strategy at Work 5-2). The ethics test in
A
Figure 5-2 provides an assessment of employees’ ethics.
S T R A T E
M
I
G Y
E
A T
W O R K
Sustainable Strategic
Management (SSM)
Strategies and related
activities that promote
superior performance from both market
and environmental
perspectives.
Managerial Ethics
An individual’s responsibility to make business
decisions that are legal,
honest, moral, and fair.
5 - 2
Good Neighbor or Good Business?
After creating considerable destruction in the5Caribbean,
Hurricane Ivan hammered the Gulf Coast of the United
0
States in September 2004. Because meteorologists
had forecast the magnitude of the storm several
5 days
prior, many Americans soon to be affected turned to
1 board up
rivals Lowe’s and Home Depot for plywood to
their homes, for power generators, and forB
other supplies. Both retailers stepped into high gear to meet conU
sumer needs.
Neither chain raised prices amidst the storm preparation and most stores made valiant attempts to remain
open as long as possible. In one respect, Home Depot
and Lowe’s went the extra mile to assist customers in
a crisis. In reality, however, remaining open extra hours
was simply good business and helped to minimize local
99
inventories that could be damaged if the stores were
devastated by the storm.
Indeed, the two rivals were well aware of possible
long-term effects that could stem from their ability
to help customers prepare for the storm. As Home
Depot’s eastern division president, Tom Taylor, put it,
“They’ll remember who got them stuff. They’ll remember who stayed open. The better job we can do during
a hurricane, [the more] we can gain market share [after
the storm].”
Could the Lowe’s and Home Depot actions be
described as good neighbor or good business? The
answer is probably both.
Sources: D. Morse, “Competing in a Crisis,” Wall Street Journal,
16 September 2004, B4, B5.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
100
Chapter 5
FIGURE
5-2
Employee Ethics Test
W
I
L
S
O
N
,
J
A
M
I
E
5
0
5
1
B
The line between social responsibility and managerial ethics can be diffiU
cult to draw, as what may be considered by some to be socially irresponsible
firm behavior may be a direct result of unethical managerial decision making.
Nonetheless, while the debate over social responsibility continues, few would
argue that managers should not behave ethically. When executives shun clear
ethical principles, corporate scandal or even demise can follow (see Strategy at
Work 5-3).
What is morally right or wrong continues to be a topic of debate, especially
when firms operate across borders where ethical standards can vary considerably.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
S T R A T E G Y
A T
W O R K
101
5 - 3
Ethical Concerns and the Corporate Scandals of 2001 and 2002
The period from mid-2001 to mid-2002 witnessed an
unprecedented number of ethical allegations and corporate misdoings that jolted Americans’ confidence in
corporate America. In August 2002, Forbes published
“The Corporate Scandal Sheet” in an effort to keep track
of the dearth of ethical violations and allegations rampant at that time. The Wall Street Journal also followed
in January 2003 with an extensive chronicle of events
for 2002. In November 2001, Enron, once one of the
world’s largest electricity and natural gas traders, admitted overstating its earnings by $567 million between
1997 and 2001 and filed for Chapter 11 bankruptcy
protection the following month. In anotherW
case, the
astute craft and décor authority Martha Stewart
I sold a
large number of her ImClone Systems shares one day
L about an
before the company released damaging news
experimental cancer drug, raising the specter
Sof insider
information and thus resulting in a conviction.
O
Although the deluge of news surrounding such
scandals began to slowly subside in late 2002,
N public
fervor concerning a perceived lack of corporate
,
accountability and widespread corporate legerdemain
has not. This fervor has been sparked further by press
reports of executive prosecutions associated with these
scandals several years later. U.S. governmental agencies have responded with new policies and procedures
designed to foster a more complete disclosure of corporate financial doings and make it more difficult for
executives to mislead investors about the performance
of their firms. These actions notwithstanding, however,
it is clear that a key part of the solution to this problem
lies in a willingness of managers at all levels to commit
to a sense of fair play and uphold ethical standards at
a personal level.
Sources: R. Alsop, “Corporate Scandals Hit Home,” Wall Street
Journal, 19 February 2004, B1, B2; P. Patsuris, “The Corporate
Scandal Sheet,” Forbes,www.forbes.com/2002/07/25/accountingtracker.html, accessed August 26, 2002; L. S. Egodigwe, J. C. Long,
and N. Warfield, “A Year of Scandals and Sorrow,” Wall Street Journal
Interactive Edition, 2 January 2003; P. Behr, “Ailing Enron Files for
Chapter 11 Bankruptcy Protection,” Washington Post, 3 December
2001, A7; C. Gasparino and S. Craig, “Merrill Worker Casts Doubt on
Stewart’s Stop-Loss Pact,” Wall Street Journal Interactive Edition,
24 June 2002.
J
A
In the United States, for example, bribes to
Mgovernment officials to secure favorable treatment would be considered unethical. In other countries—especially
those with developing economies—smallI“cash tips” are an accepted means of
transacting business and may even be considered
an integral part of an underE
paid government official’s compensation.
Ethics is a key consideration, especially at top management levels.
Selecting the right individual to serve as 5
CEO can be a perilous task, especially
when a leader departs abruptly. Although evaluating a person’s professional
0 characteristics are gaining promiqualifications is still important, personal
nence. Consider that Boeing’s CEO Harry
5 Stonecipher was dismissed in
March 2005 after directors became aware of explicit e-mails to a female
1 affair. Events such as these have
employee with whom he was having an
prompted directors to search for personal
B behavior that might disqualify
them as leaders, including sexual harassment, drinking problems, or failing
U
to file income taxes properly.17
Wal-Mart’s Thomas Coughlin ended his twenty-seven-year stint with the firm
in 2005. Originally appointed as director of loss prevention in 1978, Coughlin
was promoted to director of human resources in 1983 and president of the WalMart Stores division in 1999. In 2003, Coughlin was elected to Wal-Mart’s board.
He retired as an executive in January 2005 due to health reasons, but was forced
to resign from the board two months later when a pattern of expense account
abuses was uncovered. The investigation that uncovered the abuses began when
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
102
Chapter 5
Utilitarian View
of Ethics
Perspective suggesting that anticipated
outcomes and consequences should be the
only considerations
when evaluating an
ethical dilemma.
Self-Interest View
of Ethics
Perspective suggesting
the benefits of the decision maker should be
the primary consideration when weighing a
decision.
Rights View of Ethics
Perspective that evaluates organizational decisions on the extent
to which they protect
individual rights.
Justice View of
Ethics
Perspective suggesting
that all decisions will
be made in accordance
with preestablished
rules or guidelines.
Coughlin asked a firm lieutenant to approve $2,000 in expense payments without
providing any receipts.18
Ethical decisions are not always resolved easily and can even be observed
differently at different times. In 1991, for example, the U.S. Food and Drug
Administration (FDA) banned silicone breast implants in most instances, a decision that fueled the demise of many of its original marketers who lost billions of
dollars in lawsuits alleging product flaws, breast cancer, and other serious health
concerns. Dow Corning lost $3.2 billion in settlements and remained in bankruptcy protection from 1995 to 2004. Since that time, however, several major
studies found no link between silicone implants and major diseases. In 2006, the
FDA reapproved the sale of silicone implants. Hence, what was originally termed
as “unethical” behavior by Dow Corning is once again being touted as an acceptable product.19
What constitutes ethical behavior can be viewed in a number of ways, six of
which are discussed here. The utilitarian view of ethics suggests that anticipated
outcomes and consequences should be the only considerations when evaluating
an ethical dilemma. The
W primary shortcoming associated with this approach,
however, is that a decision may have multiple consequences, some of which may
I
be positive, others negative,
and still others undetermined. For example, a decision to layoff 10 percent
L of an organization’s workforce will harm those who lose
their jobs but may help shareholders by increasing the projected returns on their
S
investments. The long-term effect of the layoff could be positive if the organization emerges as a moreOcompetitive entity or negative if employee morale suffers
and productivity declines. Hence, the utilitarian view is not always easy to apply.
N
Research suggests that the utilitarian view is the most commonly applied perspective in organizations.20,Note, however, that these views of ethical decision making
are not always mutually exclusive. Managers often employ a combination of ethical perspectives when making decisions.
J of ethics suggests that benefits of the decision maker(s)
The self-interest view
should be the primaryAconsiderations. This view assumes that society will likely
benefit when its individual members make decisions that are in their own best
interest. As Smith andM
Friedman argued, firms that attempt to maximize their
returns within the legal
I regulations of society behave ethically. This perspective
limits ethical concerns to the consideration of short-term financial benefits for
E
the organization.
Self-interest can be viewed from either a narrow, short-run perspective or a
broader, long-term perspective, however. It can be argued that one who always
5 interests at the expense of others will suffer greater
self-promotes short-term
loss in the long term. 0
For example, firms whose managers construct loopholes
in their product or service warranties to promote short-term profits can ulti5
mately alienate their customers. Hence, ethical behavior has long-term profit
1
considerations.
The rights view of ethics evaluates organizational decisions to the extent to
B
which they protect basic individual rights, such as a customer’s right to privacy
Uto a safe work environment. The key shortcoming of this
and an employee’s right
approach, however, is that it is possible to protect individual rights at the expense
of group progress or productivity.
The justice view of ethics suggests that all decisions will be made in accordance with preestablished rules or guidelines. Employee salaries may be administered by developing a formula that computes salary based on level of experience,
amount of training, years of experience, and previous job evaluations. The key
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
shortcoming associated with the justice view is that it requires decision makers to
develop rules and procedures for every possible anticipated outcome—an arduous task indeed.
The integrative social contracts view of ethics suggests that decisions should
be based on existing norms of behavior, including cultural, community, or industry factors. Although this perspective emphasizes the situational influences on
a particular decision, it deemphasizes the need for clear standards of right and
wrong devoid of the situation.21
The religious view of ethics is based on personal or religious convictions. In
the United States, the Judeo-Christian heritage forms a distinct notion of ethics,
whereas Islam, Hinduism, and other religions comprise the majority viewpoint in
distant nations. From the Christian perspective, for example, individuals should
behave in ways that benefit others, treating other people as one would wish to
be treated.22 In one respect, the religious perspective counters the integrative
social contracts view because it emphasizes clear principles of right or wrong with
limited regard to situational variables. Needless to say, however, the religious view
would result in markedly different ethical W
perspectives across cultures with different prominent religious traditions.
I analysis may be questionable from
Some activities associated with strategic
an ethical standpoint. Few would argue that
L obtaining competitive information
from one’s own customers or purchasing and breaking down a competitor’s
S
products would be unethical. However, some companies have been known to
extensively interview managers with key competitors
for executive positions that
O
do not exist.
N
Other examples illustrate the complexities of ethical issues faced by firms.
,
In 2000, Philip Morris introduced the Merit
brand of cigarettes designed to
reduce the risk of fire when left unattended. The manufacturer claimed that
the ultrathin paper used to wrap the tobacco burns more slowly and would
J
cause fewer fires. Shortly after introduction,
however, a company scientist
reported that the cigarettes actually increase
the
risk of fire. Philip Morris
A
fired the scientist in 2002 and continued to market the cigarette, although the
M Department of Justice launched a
fire-reduction claim was avoided. The U.S.
lawsuit against Philip Morris in 2004 alleging
that the action was part of a
I
broader attempt to conceal the negative effects of cigarette smoke from the
E
public.23
In 2003, the Recording Industry Association of America launched several hundred lawsuits at teenagers and college students in an effort to emphasize the
5les via the Internet is against the law.
notion that swapping copyrighted music fi
Critics charged that “suing kids” is both0bad business and unethical; industry
executives argued that the law is clear and that widespread violations are taking
5
a serious toll on its member firms.24
1 Kraft, the largest food company in
Ethics in advertising is also a key concern.
the United States, spends about $90 million annually advertising directly to chilB
dren. In 2004 and 2005, however, the company announced plans not to direct
U and Lunchables to children under
advertisements for products such as Oreos
twelve years. When explaining the firm’s decision, executives referenced the link
between such products and obesity in children.25
Some firms and individuals indiscriminately use bulk e-mails to “spam” the
public by e-mailing unwanted direct response advertisements of pornography sites, mortgage and investment services, and the like. Studies suggest
that spam costs U.S. corporations billions of dollars each year due to loss
103
Integrative Social
Contracts View
of Ethics
Perspective suggesting
that decisions should be
based on existing norms
of behavior, including
cultural, community, or
industry factors.
Religious View
of Ethics
Perspective that evaluates organizational decisions on the basis of
personal or religious
convictions.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
104
Chapter 5
Management Focus on Ethics
A Memory Device for Making Ethical Decisions
Most people believe it is important that ethics take on a conscious, deliberate role in business decision making. The
issue of ethics boils down to asking yourself, “What price am I willing to pay for this decision, and can I live with that
price?” This process can be helped by using the word ethics as a mnemonic device.
E = EXPERIENCE. The values we carry with us into adulthood, and into business, are those that were modeled
to us, usually by a parent, teacher, or other significant adult. How people behave and the decisions they make
speak much louder and are more convincing than what they say.
T = TRAINING. Training means training yourself to keep the question of ethics fresh in your mind deliberately.
H = HINDSIGHT. Success leaves clues that we need to tap into in order to help us make that tough
decision. What if the problem you face was the problem of the person you admire most in life? What
would this person do?
I = INTUITION. What does your gut tell you is the right thing to do? Some call it conscience or insight. How do
you know when you’ve gone against your gut feeling?
W You experience guilt, shame, remorse, or perhaps a restless night. Now the decision is what to do about it?
I
C = COMPANY. How will your decision affect the company, coworkers, customers, and your family? No
matter the size of your decision, it affects other L
people in your life.
S is one that builds self-esteem through the accomplishment
S = SELF-ESTEEM. The greatest ethical decision
of goals based on how these goals positively impact those around you.
O
N
,
Sources: Adapted from F. Bucaro, “Ethical Considerations in Business,” Manage, August/September 2000, 14; A. Gaudine and L. Thorne, “Emotion
and Ethical Decision Making in Organizations,” Journal of Business Ethics, 1 May 2001, 175–187.
J
A consumption of bandwidth and other technological
of worker productivity,
resources, and the useMof technical support time. Although this largely illegal
practice is deplored by most industry groups and Internet users, enforcement
is a complicated legalIendeavor.26 Strategic managers are challenged to know
where to draw the line
Econcerning such practices.
Why do some organizations portray a pattern of unethical business practices? Anand and Ashforth identified six common rationalization tactics to
27
explain this behavior.5
First, individuals deny responsibility, rationalizing that
they have no other choice but to participate in unethical behavior. One
0 that the practice is directly associated with another’s
employee may contend
responsibility.
5
Second, individuals deny injury, suggesting that the unethical behavior did not
1 perspective defines behavior only as unethical if directly
really hurt anyone. This
injured parties can beB
clearly identified and then hesitates to acknowledge the
injury.
U
Third, individuals deny rights of the victims, rationalizing that “they deserve what
they got anyway.” This perspective rationalizes unethical behavior when competitors or other related parties are alleged to be involved at least at the same level
of corruption.
Fourth, individuals engage in social weighting by making carefully controlled
comparisons. One way this is done is by character assassination of those suggesting
that a particular pattern of behavior is unethical. If those condemning us are
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
corrupt—the argument goes—then how can credence be given to their arguments? Another way this is done is by selectively comparing the unethical action
to others whose actions are purported to be even more unethical. For example,
falsifying an expense account for meals not eaten on a business trip is not considered a major offense when compared to someone who falsifies expenses for an
entire business trip that never occurred.
Fifth, individuals can appeal to higher values by suggesting that justification of
the unethical behavior is due to a higher order value. In this sense, one might
argue that it is necessary to accept some degree of lower level unethical behavior
in pursuit to ethical responsibility at a higher level. For example, a sales rep who
is brought in to help resolve a dispute between a customer and another sales rep
may deny the legitimate claims of the customer, rationalizing that loyalty among
sales representatives is a higher order value.
Finally, individuals may invoke the metaphor of the ledger, arguing that they have
the right to engage in certain unethical practices because of other good things
they have done. For example, a manager on a business trip may justify padding
a travel expense account because she has W
already done “more than her share” of
traveling in recent months.
I
Improving the ethical stance of an organization
is not easy, however. Treviño
and Brown identify five commonly held L
myths concerning ethics in organizations.28 These myths and accompanying realities are summarized in Table 5-2.
S
In concert, they argue that ethical decision making is a complex process that
extends beyond removing the bad applesOfrom the organization and establishing formal ethics codes. It begins with proactive behavior on the part of top
N
executives that infuses ethics into the fabric of the organization.
,
5-4 The Agency Problem
J
Ideally, top management should attempt to maximize the return to shareA
holders on their investment while simultaneously
satisfying the interests of
other stakeholders. For as long as absentee owners (i.e., the shareholders)
TA B L E
5-2
M yths and R ea lities
Myth
M
I
o f Orga niza tio na l
E
Eth ics
Reality
1. Ethical decision making is easy.
2. Unethical behavior can be traced
to a limited number of bad apples
in an organization.
3. Ethics can be managed by
developing formal ethics codes
and programs.
4. Ethical leadership is really about
leader morality and honesty.
5. Business leaders are less ethical
today than they used to be.
5 decision making is a complex
Ethical
process.
0
Unethical behavior can be a systemic part
of
5the organization’s culture.
1 codes and programs are helpful,
Formal
but ethical expectations must be part of
B culture and fabric of the organization.
the
Leader morality and honesty is a good
U
start, but the leader must also infuse
ethics into the organization and hold
others accountable.
Ethical concern in organizations has
always been a pervasive issue.
Source: Based on L. K. Treviño and M. E. Brown, “Managing to Be Ethical: Debunking Five Business Ethics
Myths,” Academy of Management Executive 18(2) (2004): 69–81.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
105
106
Chapter 5
Source: Ablestock.com
Agency Problem
A situation in which
a firm’s top managers
(i.e., the “agents” of the
firm’s owners) do not act
in the best interests of
the shareholders.
have been hiring professionals to manage their companies, however, questions have been raised concerning the degree of emphasis these managers
actually place on maximizing financial returns.29 Of course, managers emphasizing their own goals over those of the shareholders would raise serious ethical questions.
This concern has become more prominent in recent years as shares of publicly
traded firms are more widely dispersed, making it harder for shareholders to
exert control over a firm. For this reason, it is not uncommon to see successful,
small, privately held firms seeking to stay small so the owner can remain personally in charge of the major business decisions.
The agency problem refers to a situation in which a firm’s managers—
the so-called agents of the owners—fail to act in the best interests of the
shareholders. The extent to which the problem adversely affects most firms is
widely debated, and factors associated with the problem can vary from country to country.30 Indeed, some argue that management primarily serves its
own interests, whereas others contend that managers share the same interests
as the shareholders. These
W two perspectives are briefly discussed in sections 5-4a
and 5-4b.
I
L Serves Its Own Interests
5-4a Management
According to one perspective,
top managers tend to pursue strategies that
S
ultimately increase their own salaries and other rewards. In particular, top
Ogrow their firms because increases in rewards usually
executives are likely to
accompany increasesN
in organizational size and its greater responsibilities,
even if growth is not the optimal strategy for the firm. This perspective is
, for management salaries to increase as the organizabased on the tendency
tion grows.31
Excessive CEO compensation has been widely criticized in recent years.32
J
Although what is considered excessive varies among stakeholders, many CEOs
have come under fireA
for their annual compensation. According to a number
of surveys, most managers believe CEOs earn too much. During the 1980s, CEO
M
compensation rose by 212 percent, compared to only 54 percent for factory workI
ers, 73 percent for engineers,
and 95 percent for teachers. After a brief decline in
the early 1990s, CEO salaries
began
to climb once again.
E
In addition to salary, CEOs typically receive stock options and bonuses, revenues from profit-sharing plans, retirement benefits, and interest-free loans. As
a result, CEOs in America’s
5 350 largest publicly held corporations average more
than $3 million annually in salary and bonuses, a figure that has declined only
once in the past ten 0
years. Recently, however, corporate boards have taken a
closer look at CEO pay
5 to ensure a tighter link between company performance
and total compensation.
1
Hewlett-Packard’s former
CEO, Carly Fiorina, was one of the highest paid
chief executives in the
Bworld, with a compensation package valued at nearly
$90 million when she joined the company in 2000. The intriguing element of
U
the package, however, was a grant for the equivalent of 580,000 restricted HP
shares over three years, a block of stock worth $66.1 million when Fiorina’s
tenure began. When HP fired her in 2005, Fiorina received cash, stock, and
pension benefits worth about $40 million, prompting protests from union officials and shareholders alike.33
Limiting CEO pay is not easy. Whole Foods Market attempted to restrict
the pay of its CEO in the 1980s to eight times that of the average worker,
a multiple that crept upward and was raised to nineteen times in 2006 to
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
keep the firm from losing key leaders to competitors.34 Hence, it is not
surprising that political interest in regulating or limiting CEO pay is a hot
topic. In 2007, some U.S. lawmakers supported legislation allowing shareholders to veto any CEO pay packages. A number of academics, mutual-fund
trustees, institutional investors, union leaders, and politicians have taken
a stand on this issue.35 CEO pay can become a complex issue when a firm
is going through a financial crisis and demanding sacrifices from the rank
and file. Gerard Arpey, chairman and CEO of American Airlines (AMR),
accepted stock options as part of his compensation, but turned down promotion raises in 2004.36 In addition, many firms have discovered difficulties when attempting to reclaim pay from executives even in the case of
malfeasance. 37
CEOs in the United States earn on average far more than their counterparts
in other countries; however, U.S. firms have become more likely than their global
counterparts to employ non-Americans as CEOs. Interestingly, a number of studies have demonstrated that CEO salary is more closely tied to company size than
to performance. Recently, however, firms W
have begun to tie compensation more
closely to corporate performance. Most firms appear willing to continue to pay
large sums to chief executives, provided Ithe corporation performs at a comparable level. Surveys of CEO compensationLpractices continue to uncover special
arrangements and considerable bonuses.
S
Pay practices in Internet businesses have also changed. Many Internet-based
companies have increasingly adopted short-term
incentives and bonus plans that
O
are tied to more traditional business performance metrics, such as increased revN
enue or nearing profitability.
,
Executives may also pursue diversification,
the process of increasing the
size of their firms by acquiring other companies that may be related to the
firm’s core business. Diversification not only increases a firm’s size but may also
J
improve its survivability by spreading operational
risks among its various business units. Diversification pursued only toAspread risk, however, is generally not
in the best interest of shareholders, who always have the option of reducing their
financial risks by diversifying their own fiM
nancial portfolios.38 This perspective
does not necessarily suggest that top management
is unconcerned with the
I
firm’s profitability or market value; rather, top managers may emphasize business performance only to the extent that E
it discourages shareholder revolts and
hostile takeovers.
The extent to which this perspective is accurate can create an advantage for
5 whose owners actively manage the
relatively small, entrepreneurial organizations
firm. For this reason, such firms may be able
0 to compete aggressively and successfully with their larger, more established competitors.
107
Diversification
The process of acquiring companies to
increase a firm’s size.
5
1 Share
5-4b Management and Stockholders
the Same Interests
B
Because managers’ livelihoods are directly related to the success of the firm, one
U
can argue that managers generally share the same interests as the stockholders.
This perspective is supported at least in part by several empirical studies. One
study, for example, found that firm profit—not size—is the primary determinant of top management rewards.39 Another points to a significant relationship between common stock earnings and top executives’ salaries.40 Hence,
according to these studies, management rewards rise with firm performance,
a relationship that encourages managers to be most concerned with company
performance.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
108
Chapter 5
Employee Stock
Ownership Plan
(ESOP)
A formal program that
transfers shares of
stock to a company’s
employees.
One of the most common suggestions for aligning the goals of top management and those of shareholders is to award shares of stock or stock options
to top management, transforming professional managers into shareholders.
Stock option plans and high salaries may bring the interests of top management and stockholders closer together.41 Top executives seek to protect their
salaries and option plans and can do so only by delivering higher business performance. Indeed, research has suggested that as managerial stock ownership
rises, the interests of managers and shareholders begin to converge to some
extent.42 This view has gained support from others, but for different reasons.43
Many suggest that managerial jobs contain structural imperatives that force
managers to attempt to enhance profits.44 In addition, when managers are
major shareholders, they may become entrenched and risk averse, adopting
conservative strategies that are beneficial to themselves but not necessarily to
their shareholders.
In sum, the debate over whether top managers are primarily concerned
with their firms’ returns or their own interests continues. Most scholars and
practitioners believe both
W perspectives have merit, and pursue compensation
models designed to bring the two sides together, such as those that emphasize
I t sharing for managers instead of fixed pay levels. Many
stock options and profi
companies have adopted
L employee stock ownership plans (ESOPs) to distribute shares of the company’s stock to managers and other employees over a
S
period of time.
5-5
Corporate
Governance
The board of directors,
institutional investors,
and blockholders who
monitor firm strategies
to ensure managerial
responsiveness.
O
N
Corporate
,
Governance and Goals
of Boards of Directors
Corporate governance refers to the board of directors, institutional invesJ retirement funds, mutual funds, banks, insurance
tors (e.g., pension and
companies, among other
A money managers), and large shareholders known
as blockholders who monitor firm strategies to ensure effective management.
M institutional investors—representatives of pension
Boards of directors and
and retirement funds,I mutual funds, and financial institutions—are generally
the most influential in the governance systems. Boards of directors represent
the shareholders andE
are legally authorized to monitor firm activities, as well
as the selection, evaluation, and compensation of top managers. Because institutional investors own more than half of all shares of publicly traded firms,
5
they tend to wield substantial influence. Blockholders tend to hold less than
0 so their influence is proportionally less than that of
20 percent of the shares,
institutional investors.45
5
Boards often include both inside (i.e., firm executives) and outside directors.
1
Insiders bring company-specifi
c knowledge to the board, whereas outsiders bring
independence and anBexternal perspective. Over the past several decades, the
composition of the typical board has shifted from one controlled by insiders
U
to one controlled by outsiders.
This increase in outside influence often allows
board members to oversee managerial decisions more effectively.46 Furthermore,
when additional outsiders are added to insider-dominated boards, CEO dismissal
is more likely when corporate performance declines,47 and outsiders are more
likely to pressure for corporate restructuring.48
In the 1990s, the number of corporate board members with memberships
in other boards began to increase dramatically. With outside directors of the
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
largest 500 firms in the United States commanding an average of $151,000
in cash and equity in 2005, companies often became concerned about both
potential conflicts of interest and the amount of time each individual can
spend with the affairs of each company. As a result, many companies have
begun to limit the number of board memberships their own board members
may hold. Approximately two-thirds of corporate board members at the largest 1,500 U.S. companies do not hold seats on other boards. In addition, some
firms are reconsidering board member compensation. In 2006, for example,
Coke unveiled a plan that pays its board members only if the company hits
earnings targets. The plan, however, does pay new members $175,000 as a
signing bonus.49
This change has been underscored by the Sarbanes-Oxley Act of 2002, which
requires that firms include more independent directors on their boards and
make new disclosures on internal controls, ethics codes, and the composition
of their audit committees on annual reports. Analysts have noted positive
changes among boards as a result of this legislation in terms of both independence and expertise.50 Evidence also suggests
W that many CEOs have become
more reluctant to sit on boards of publicly held companies. Increased liability
on the part of board members and recentI policy changes that often restrict the
number of outside boards on which a CEO
L may serve have also contributed to
this change.51
S
Even with new disclosure regulations, it can be difficult to determine precisely what top executives earn at public
O companies. In 2004, for example,
Regions Financial, Ryland Group, and Home Depot each reimbursed their
N
top executives more than $3 million for personal taxes levied on executive
perks. Details of such payments are not,always readily available in corporate
filings.52
Boards of directors consist of officials elected by the shareholders and are
responsible for monitoring activities in theJorganization, evaluating top management’s strategic proposals, and establishing
A the broad strategic direction for the
firm, although few boards tend to be aggressive in this regard. As such, boards
Mthe chief executive officer, establishare responsible for selecting and replacing
ing the CEO’s compensation package, advising
top management on strategic
I
issues, and monitoring managerial and company performance as representatives
E that board members do not always
of the shareholders. Critics charge, however,
53
fulfill their legal roles. One reason is board members are nominated by the
CEO, who expects them to support his or her strategic initiatives. The generous
5 issue.54
compensation they often receive is also a key
When boards are controlled by insiders,
0 a rubber stamp mentality can
develop, whereby directors do not aggressively challenge executive decisions
5
as they should. This is particularly true when the CEO also serves as chair of
1 duality.55 Although research shows
the board, a phenomenon known as CEO
mixed results concerning the desirability of CEO duality,56 insider board memB
bers may be less willing to exert control when the CEO is also the chair of the
U career prospects within the firm
board, because present rewards and future
are largely determined by the CEO. In the absence of CEO duality, however,
insiders may be more likely to contribute to board control, often in subtle and
indirect ways so as not to document any opposition to the decisions of the CEO.
For example, the insiders may ostensibly present both sides of various issues,
while carefully framing the alternatives in favor of one that may be in opposition to the wishes of the CEO.
109
CEO Duality
A situation in which the
CEO also serves as the
chair of the board.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
110
Chapter 5
S T R A T E G Y
A T
W O R K
5 - 4
The Growing Responsiveness of Boards
The adage on Wall Street is, “If you don’t like the stock,
sell it.” Over the past decade, however, dismayed investors have decided to challenge the board instead. Many
corporate boards have historically functioned as rubber
stamps for top executives. Nonetheless, the directors
of many prominent corporations have become increasingly responsible to shareholder interests, thanks in
part to the increased influence of institutional shareholders. These large investment firms control substantial numbers of shares in widely held firms and have
the clout necessary to pressure board members for
change when needed.
W
Consider the case of Nell Minow. A principal at activist money-management firm Lens Inc., Minow searches
I
for companies with strong products and underlying
L
values that appear to be underperforming. After identifying a target, Minow purchases a substantial number
S
of shares in the company and then advises the CEO
O
of her ownership position. She requests a meeting
with the CEO and/or the board to discuss changes
N
that could improve the performance of the firm. Activist
,
owners like Minow have sent a message to both top
executives and boards that poor performance is not
unlikely to go unchallenged.
J
However, a number of analysts and executives believe
that further change to the system is needed. According to
David Leighton, former chairman of the board at Nabisco
Brands, Ltd., companies should seek out more independent and qualified board members who will consider the
strategic direction of the firm more aggressively.
In some instances, boards of directors, pressured
by institutional investors, have forced the turnover
of top executives. In one prominent example, GM’s
market share declined from 44 percent to 33 percent between 1981 and 1992. In 1992, the California
Public Employees Retirement System, a significant
shareholder, pressured the eleven outside board members (a majority of the fifteen-member board) to reassert strategic control over the firm. As a result, the
shareholder forced a complete overhaul of senior GM
executives, the first since 1920. GM generated profits
of $2.6 billion, $7.6 billion, and $9.7 billion in 1993,
1994, and 1995, respectively.
Sources: N. Dunne, “Adding a Little Muscle in the Boardroom,”
Financial Times, 10 October 2003, I; W. Royal, “Impeach the
Board,” Industry Week, 16 November 1998, 47–50; C. Torres,
“Firms’ Restructuring Often Hurt Foreign Buyers,” Wall Street Journal
Interactive Edition, 13 May 1996; M. L. Weidenbaum, “The Evolving
Corporate Board,” Society, March–April 1995, 9–16.
A
M
I to acknowledge shareholder concerns has increased
Pressure on directors
over the past two decades.
E The major source of pressure in recent years has come
from institutional investors, owners of large chunks of most publicly traded companies by way of retirement or mutual funds. By virtue of the size of their investments, they wield considerable
power and are more willing to use it than ever
5
before (see Strategy at Work 5-4).
0 have played effective stewardship roles. Many directors
Some board members
promote strongly the best
5 interests of their firm’s shareholders and various other
stakeholder groups as well. Research indicates, for instance, that board members
1 of environmental and competitive information.57 By
are often invaluable sources
conscientiously carrying
B out their duties, directors can ensure that management
remains focused on company performance.58
U
A number of recommendations have been made on how to promote an effective governance system. For example, it has been suggested that outside directors be the only ones to evaluate the performance of top managers against the
established mission and goals, that all outside board members meet alone at least
once annually, and that boards of directors establish appropriate qualifications
for board membership and communicate these qualifications to shareholders.
For institutional shareholders, it is recommended that institutions and other
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
111
shareholders act as owners and not just investors,59 that they not interfere with
day-to-day managerial decisions, that they evaluate the performance of the board
of directors regularly,60 and that they recognize that the prosperity of the firm
benefits all shareholders.
5-6 Takeovers
When shareholders conclude that the top managers of a firm with ineffective
board members are mismanaging the firm, institutional investors, blockholders, and other shareholders may sell their shares, depressing the market price
of the company’s stock.61 Depressed prices often lead to a takeover, a purchase
of a controlling quantity of a firm’s shares by an individual, a group of investors, or another organization. Takeovers may be attempted by outsiders or
insiders, and may be friendly or unfriendly. A friendly takeover is one in which
both the buyer and seller desire the transaction. In contrast, an unfriendly
takeover is one in which the target firm resists the sale, whereby one or more
W
individuals purchase enough shares in the target firm to either force a change
in top management or to manage the fiIrm themselves. Interestingly, groups
that seek to initiate unfriendly takeovers often include current or former firm
L
executives.
S rely heavily on borrowed funds
In many cases, sudden takeover attempts
to finance the acquisition, a process referred
O to as a leveraged buyout (LBO).
LBOs strap the company with heavy debt and often lead to a partial divestment of some of the firm’s subsidiariesNof product divisions to lighten the
burden.62
,
Corporate takeovers have been both defended and criticized. On the
positive side, takeovers provide a system of checks and balances often
required to initiate changes in ineffective
J management. Proponents argue
that the threat of LBOs can pressure managers to operate their firms more
A
efficiently. 63
Takeovers have been criticized from several
perspectives. The need to pay
M
back large loans can cause management to pursue activities that are expedient
in the short run but not best for the firm Iin the long run. In addition, the extra
debt required to finance an LBO tends toEincrease the likelihood of bankruptcy
for a troubled firm.64
Takeover
The purchase of a
controlling quantity of
shares in a firm by an
individual, a group of
investors, or another
organization. Takeovers
may be friendly or
unfriendly.
Leveraged Buyout
(LBO)
A takeover in which
the acquiring party
borrows funds to
purchase a firm.
5
0
An organization’s mission outlines the reason
5 for its existence. A clear purpose
provides managers with a sense of direction and can guide all of the organization’s
1 ends toward which organizational
activities. Goals represent the desired general
efforts are directed. However, managers, B
shareholders, and board members do
not always share the same goals. Top management must attempt to reconcile
U
and satisfy the interests of each of the stakeholder
groups while pursuing its own
5-7 Summary
goals. Inherent in the notion of mission and goals is the organization’s position on social responsibility and the ethical standards it expects its managers to
uphold.
Takeovers and leveraged buyouts have emerged as mechanisms for resolving
some of the goal conflicts that occur among various stakeholder groups. The
usefulness of these mechanisms continues to be widely debated, however.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
112
Chapter 5
Key Terms
agency problem
CEO duality
comparative advantage
corporate governance
diversification
employee stock ownership
plan (ESOP)
goals
integrative social contracts view
of ethics
justice view of ethics
leveraged buyout
managerial ethics
mission
objectives
religious view of ethics
W
I
1. What is and should be the relationship between L
an
organization’s mission and its strategy?
S
2. What is the difference between social responsibility
O
and managerial ethics?
3. Select a company that has published a mission stateN
ment on its Web site. Evaluate its mission statement
,
along each of the following criteria.
rights view of ethics
self-interest view of ethics
social responsibility
stakeholders
sustainable strategic management
takeover
utilitarian view of ethics
Review Questions and Exercises
a. Is the mission statement comprehensive? Is it
concise?
Practice Quiz
J
A
M
I
E
True or False
b. Does the mission statement delineate, in broad terms,
what products or services the firm is to offer?
c. Is the mission statement consistent with the company’s actual activities and competitive prospects?
4. Why do stakeholders in the same organization often
have different goals? Would it not be best if they
shared the same goals? Explain.
5. What are the key advantages and disadvantages of
leveraged buyouts?
Multiple Choice
1. Goals are specific and often quantified versions5of
objectives.
0
2. If a firm is able to consistently earn above-average
profits, then it is effectively balancing the goals5of
its stakeholders.
1
3. The agency problem refers to the balancing act a
B
firm must exhibit when attempting to satisfy the
myriad of governmental agencies.
U
4. A firm’s managers may pursue diversification even
if performance is likely to suffer because diversification can reduce the risk of firm failure.
5. A common suggestion for aligning the goals of top
management and those of shareholders is to award
shares of stock or stock options to top management.
6. Most boards of directors include both inside and
outside directors.
7. The reason for the firm’s existence is known as
A. the vision.
B. organizational goals.
C. organizational objectives.
D. none of the above
8. The idea that certain products may be produced
more cheaply or at a higher quality in particular
countries due to advantages in labor costs or technology is known as
A. comparative advantage.
B. competitive advantage.
C. strategic advantage.
D. national advantage.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
9. Which of the following is not an example of a
stakeholder?
A. customers
B. suppliers
C. employees
D. none of the above
10. An individual’s responsibility to make business
decisions that are legal, honest, moral, and fair is
known as
A. social responsibility.
B. the social imperative.
C. managerial ethics.
D. all of the above
W
I
L
Notes
S
1. NewswireToday.com, “Software Development Engineer in
India Vs China, accessed June 14, 2007, http://www.
O
newswiretoday.com/news/4319; P. Wonacott, “China’s
Secret Weapon: Smart, Cheap Labor for High Tech
NGoods,”
Wall Street Journal (14 March 2002): A1.
2. T. Eiben, “U.S. Exporters on a Global Roll,” Fortune, (29 June
1992): 94.
3. R. Jacob, “The Search for the Organization of Tomorrow,”
Fortune (18 May 1992): 93.
4. A. L. Friedman and S. Miles, “Developing Stakeholder Theory,”
Journal of Management Studies 39 (2002): 1–22.
5. S. I. Wu and C. Wu, “A New Market Segmentation Variable
for Product Design-Functional Requirements,” Journal of
International Marketing and Marketing Research 25 (2000):
35–48.
6. For an example of his early work, see R. Nader, Unsafe at
Any Speed: Design and Dangers of the American Automobile
(New York: Grossman, 1964).
7. H. A. Simon, “On the Concept of Organizational Goal,”
Administrative Science Quarterly 9 (1964): 1–22; J. Pfeffer
and G. Salancik, The External Control of Organizations (New
York: Harper & Row, 1978).
8. R. M. Cyert and J. G. March, A Behavioral Theory of the Firm
(Englewood Cliffs, NJ: Prentice-Hall, 1963); J. G. March and
H. A. Simon, Organizations (New York: John Wiley & Sons,
1958).
9. M. J. Verkerk, J. DeLeede, and A. H. J. Nijhof, “From
Responsible Management to Responsible Organizations: The
Democratic Principle for Managing Organizational Ethics,”
Business and Society Review 106 (2001): 353–378; A.
E. Randel, “The Maintenance of an Organization’s Socially
Responsible Practice: A Cross-Level Framework,” Business
and Society 41 (2002): 61–83.
10. R. Alsop, “Survey Rates Companies’ Reputations and Many
Are Found Wanting,” Wall Street Journal (7 February 2001):
B1, B6.
J
A
M
I
E
5
0
5
1
B
U
11. R. Alsop, “Perils of Corporate Philanthropy,” Wall Street
Journal (16 January 2002): B1, B4.
113
11. The board of directors is responsible for
A. selecting the CEO.
B. determining the CEO’s compensation package.
C. overseeing the firm’s strategies.
D. all of the above
12. Leveraged buyouts can
A. strap the company with a large amount of debt.
B. serve as a system of checks and balances.
C. lead to the sale of company assets.
D. all of the above
12. Ibid.; A. Maitland, “No Hiding Place for the Irresponsible
Business,” special report in Financial Times (29 September
2003): 1–2.
13. R. J. Ely and D. A. Thomas, “Cultural Diversity at Work: The
Effects of Diversity Perspectives on Workgroup Processes
and Outcomes,” Administrative Science Quarterly 46 (2001):
229–273.
14. J. Whalen, “Britain Stirs Outcry by Weighing Benefits of
Drugs Versus Price,” Wall Street Journal (22 November
2005): A1, A11.
15. A. Browne, “Chinese Doctors Tell Patients: Pay Upfront, or
No Treatment,” Wall Street Journal (5 December 2005):
A1, A12.
16. A. Zimmerman, “Defending Wal-Mart,” Wall Street Journal
Online (6 October 2004).
17. C. Hymowitz, “The Perils of Picking CEOs,” Wall Street Journal
(15 March 2004): B1, B4.
18. J. Bandler and A. Zimmerman, “A Wal-Mart Legend’s Trail of
Deceit,” Wall Street Journal, (8 April 2005): A1, A10.
19. R. L. Rundle and A. W. Mathews, “Breast Implants Made
of Silicone Win FDA Backing,” Wall Street Journal (18–19
November 2006): A1, A5.
20. D. J. Fritzsche and H. Becker, “Linking Management Behavior
to Ethical Philosophy—An Empirical Investigation,” Academy
of Management Journal 27 (1984): 166-175.
21. E. Soule, “Managerial Moral Strategies—In Search of a
Few Good Principles,” Academy of Management Review 27
(2002): 114–124.
22. G. R. Weaver and B. R. Agle, “Religiosity and Ethical Behavior
in Organizations: A Symbolic Interactionist Perspective,”
Academy of Management Review 27 (2002): 77–97.
23. V. O’Connell, “U.S. Suit Alleges Philip Morris Hid CigaretteFire Risk,” Wall Street Journal (23 April 2004): A1, A8.
24. C. Bialik, “Will the Music Industry Sue Your Kid?” Wall Street
Journal (10 September 2003): D1, D12.
25. S. Ellison, “Why Kraft Decided to Ban Some Food Ads to
Children,” Wall Street Journal (31 October 2005): A1, A13.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
114
Chapter 5
26. M. Mangalindan, “For Bulk E-Mailer, Pestering Millions Offers
Path to Profit,” Wall Street Journal (13 November 2002):
A1, A17; B. Morrissey, “Spam Cost Corporate America
$9B in 2002,” (7 January 2003), study by Ferris Research
reprinted at www.cyberatlas.com.
27. B. E. Ashforth and V. Anand, “The Normalization of Corruption
in Organizations,” in R. M. Kramer and B. M. Staw, eds.,
Research in Organizational Behavior 25 (2003): 1–52
(Amsterdam: Elsevier Publishing).
28. L. K. Treviño and M. E. Brown, “Managing to be Ethical:
Debunking Five Business Ethics Myths,” Academy of
Management Executive 18(2) (2004): 69–81.
29. B. M. Staw and L. D. Epstein, “What Bandwagons Bring:
Effects of Popular Management Techniques on Corporate
Performance, Reputation, and CEO Pay,” Administrative
Science Quarterly 45 (2000): 523–556.
30. K. Ramaswamy, R.Veliyath, and L. Gomes, “A Study of the
Determinants of CEO Compensation in India,” Management
International Review 40 (2000): 167–191.
31. J. E. Richard, “Global Executive Compensation: A Look at the
Future,” Compensation and Benefits Review 32(3) (2000):
35–38.
32. J. S. Dublin, “Why the Get-Rich-Quick Days May Be Over,”
Wall Street Journal (14 April 2003): R1, R3; J. S. Lublin,
“Executive Pay Keeps Rising, Despite Outcry,” Wall Street
Journal (3 October 2003): B1, B4; C. Hymowitz, “Does
Rank Have Too Much Privilege? Wall Street Journal
(26 February 2002): B1; C. Dembeck, “Is Amazon.com’s CEO
Package Too Generous?” E-Commerce Times Columnist
(31 August 1999); C. Dembeck, “HP’s New CEO Package
Is a Sweetheart Deal,” E-Commerce Times Columnist
(27 September 1999); L. Enos, “Study: Dot–Compensation
Going Mainstream,” E-Commerce Times (22 August
2000); P. Wright, M. Kroll, and J. A. Parnell, Strategic
Management:Concepts (Upper Saddle River, NJ: Prentice
Hall, 1998); C. Hymowitz, “Foreign-Born CEOs Are
Increasing in U.S., Rarer Overseas,” Wall Street Journal
(25 May 2004): B1, B6.
33. R. Mark, “HP Stockholders after Fiorina Severance,” Internet
News (9 March 2006).
34. P. Dvorak, “Limits on Executive Pay: Easy to Set, Hard to
Keep,” Wall Street Journal (9 April 2007): B1, B5.
35. J. S. Lublin and P. Dvorak, “How Five New Players Aid
Movement to Limit CEO Pay,” Wall Street Journal (13 March
2007): A1, A20.
36. J. S. Lublin, “Cost-Cutting Airlines Grapple with Issue of
Executive Pay,” Wall Street Journal (25 January 2005):
B1, B9.
37. P. Dvorak and S. Ng, “Companeis Discover It’s Hard to
Reclaim Pay from Executives,” Wall Street Journal
(20 November 2006): A1, A12.
38. D. J. Teece, “Towards an Economic Theory of the
Multiproduct Firm,” Journal of Economic Behavior and
Organization 3 (1982): 39–63.
39. W. G. Lewellen and B. Huntsman, “Managerial Pay and
Corporate Performance,” American Economic Review 60
(1970): 710–720.
40. R. T. Masson, “Executive Motivations, Earnings, and
Consequent Equity Performance,” Journal of Political
Economy 79 (1971): 1278–1292.
41. J. Child, The Business Enterprise in Modern Industrial Society
(London: Collier-Macmillan, 1969).
42. S. L. Oswald and J. S. Jahera, “The Influence of Ownership
on Performance: An Empirical Study,” Strategic Management
Journal 12 (1991): 321–326.
W
I
L
S
O
N
,
J
A
M
I
E
5
0
5
1
B
U
43. D. R. James and M. Soref, “Profit Constraints on Managerial
Autonomy: Managerial Theory and the Unmaking of the
Corporation President,” American Sociological Review 46
(1981): 1–18.
44. C. R. Weinberg, “CEO Compensation: How Much Is Enough?”
Chief Executive 159 (2000): 48–63.
45. S. Chen and K. W. Ho, “Blockholder Ownership and Market
Liquidity,” Journal of Financial & Quantitative Analysis
35 (2000): 621–633; J. J. McConnell and H. Servaes,
“Additional Evidence on Equity Ownership and Corporate
Value,” Journal of Financial Economics 27 (1990):
595–612.
46. W. J. Salmon, “Crisis Prevention: How to Gear Up Your
Board,” Harvard Business Review 71 (1993): 68–75.
47. See B. Hermalin and M. S. Weisbach, “The Determinants
of Board Composition,” Rand Journal of Economics 19(4)
(1988): 589–605; E. F. Fama and M. C. Jensen, “Separation
of Ownership and Control,” Journal of Law and Economics 26
(1983): 301–325; M. S. Weisbach, “Outside Directors and
CEO Turnover,” Journal of Financial Economics 20 (1988):
431–460.
48. P. A. Gibbs, “Determinants of Corporate Restructuring: The
Relative Importance of Corporate Governance, Takeover
Threat, and Free Cash Flow,” Strategic Management Journal
14 (1993): 51–68.
49. C. Terhune and J. S. Lublin, “In Unusual Move, Coke Ties Pay
for Directos to Earnings Targets,” Wall Street Journal (6 April
2006): A1, A11; P. Plitch, “Ready and Able?” Wall Street
Journal (24 February 2003): R3, R5; J. S. Lublin, “More Work,
More Pay,” Wall Street Journal (24 February 2003): R4, R5.
50. N. Dunne, “Adding a Little Muscle in the Boardroom,”
Financial Times (10 October 2003): I.
51. A. Raghavan, “More CEOs Say ‘No Thanks’ to Board Seats,”
Wall Street Journal (28 January 2005): B1, B4.
52. M. Maremont, “Latest Twist in Corporate Pay: Tax-Free
Income for Executives,” Wall Street Journal (22 December
2005): A1, A11.
53. J. H. Morgan, “The Board of Directors Is No Longer Just a
‘Rubber Stamp,’” TMA Journal 19(5) (1999): 14–18.
54. B. R. Baliga and R. C. Moyer, “CEO Duality and Firm
Performance,” Strategic Management Journal 17 (1996):
41–53; P. Stiles, “The Impact of Board on Strategy: An
Empirical Examination,” Journal of Management Studies 38
(2001): 627–650.
55. S. Finkelstein and R. D’Aveni, “CEO Duality as a DoubleEdged Sword,” Academy of Management Journal 37 (1994):
1079–1108.
56. P. Allan and A. A. Widman, “A Comparison of the Views
of CEOs and Public Pension Funds on the Corporate
Governance Issues of Chairman-CEO Duality and Election
of Lead Directors,” American Business Review 18(1) (2000):
49–54; W. N. Davidson III, D. L. Worrell, and C. Nemec,
“CEO Duality, Succession-Planning and Agency Theory:
Research Agenda,” Strategic Management Journal 19 (1998):
905–908.
57. J. Goldstein, K. Gautum, and W. Boeker, “The Effects of
Board Size and Diversity on Strategic Change,” Strategic
Management Journal 15 (1994): 241–250.
58. M. S. Mizruchi, “Who Controls Whom? An Examination of
the Relation between Management and Board of Directors
in Large American Corporations,” Academy of Management
Review 8 (1983): 426–435.
59. C. Wohlstetter, “Pension Fund Socialism: Can Bureaucrats
Run the Blue Chips?” Harvard Business Review 71
(1993): 78.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
60. J. A. Conger, D. Finegold, and E. E. Lawler III, “Appraising
Boardroom Performance,” Harvard Business Review 76(1)
(1998): 136–148.
61. P. Wright and S. Ferris, “Agency Conflict and Corporate
Strategy: The Effect of Divestment on Corporate
Value,” Strategic Management Journal 18 (1997):
77–83.
62. S. Perumpral, N. Sen, and G. Noronha, “The Impact of LBO
Financing on Bank Returns,” American Business Review
20(1) (2002): 1–5.
115
63. M. C. Jensen, “The Eclipse of the Public Corporation,” Harvard
Business Review 67(5): 61–74; P. H. Pan and C. W. L. Hill,
“Organizational Restructuring and Economic Performance
in Leveraged Buyouts,” Academy of Management Journal 38
(1995): 704–739.
64. R. B. Reich, “Leveraged Buyouts: America Pays the
Price,” New York Times Magazine (29 January 1989):
32–40.
W
I
L
S
O
N
,
J
A
M
I
E
5
0
5
1
B
U
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
116
Chapter 5
R E A D I N G
5 - 1
Insight from strategy+business
This chapter’s strategy+business reading highlights the fact that progressive firms can meet social challenges
while securing profits. South African power company Eskom anticipated the end to apartheid and has facilitated social change in the country by providing electricity to sections of the country dominated by a poor, predominantly black population.
The Company that Anticipated History
By Ann Graham
D
riving along the old two-lane road from the
Republic of South Africa’s political capital,
W
Pretoria, to its commercial hub, Johannesburg,
a visitor sees two strikingly different nations.
I
The first South Africa looks like an emerging econL
omy in hypergrowth. Hundreds of acres of rolling hillsides are rapidly giving way to new four-lane highways,
S
office parks, shopping centers, and housing developO
ments of modest and McMansion-style homes. Parking
lots in Johannesburg suburbs are jammed with BMWs,
N
Mercedes-Benzes, and Range Rovers. A supermarket
,
called Woolworth’s resembles the American hautehealthy food emporium Whole Foods; an apparel store,
Kozi Kids, looks like the Gap. Bars and restaurants
J
cater to young, university-educated, upwardly mobile
professional blacks—a category that didn’t exist 15
A
years ago. It emerged after the 1994 national election,
M
which brought Nelson Mandela and the African National
Congress (ANC), the country’s oldest black rights orgaI
nization, to power.
E
The second South Africa consists of a predominantly
black population mired in poverty. Next door to many of
the new malls and mansions are sprawling shantytowns
5
of rusting metal shacks. Men and women in tattered
0
clothes walk from them daily through tall grasses down
to the urban roads. On their heads, some balance bas5
kets filled with fruits and vegetables or trinkets they will
1
try to sell to travelers. Day laborers jam themselves into
ramshackle minivan taxis that take them to pickup points
B
for construction or farm work. If they’re not lucky enough
to land those jobs, these itinerant workers might end U
up
in a crowded shopping center parking lot, directing cars
to open spaces and hoping to receive a small tip for their
service.
South Africa’s president, Thabo Mbeki, calls these
two South Africas the “first” and “second” economies.
They are a legacy of apartheid, the system of racial
segregation that governed South Africa from 1946 to
1994, effectively excluding nonwhites (who make up
79 percent of South Africa’s 47 million people) from the
nation’s economy and politics. Even with GDP growth
averaging 3 percent since 1994, and more blacks rising
out of poverty to enter the first economy, whites’ per
capita income of 82,000 rand (US$11,000) is still more
than five times that of blacks, and black unemployment
remains a problem. Officially, unemployment nationwide
stands at about 27 percent. Unofficially, the rate is anywhere from 40 to 75 percent among blacks.
Access to electricity is always an important first step
up the economic ladder. In South Africa, Eskom Holdings
Ltd. provides that first step. A government-owned corporation headquartered in the Johannesburg suburb of
Sandton, Eskom generates 95 percent of the country’s
electricity. Many organizations debate whether their
business has social responsibilities, but Eskom’s core
business is itself a social responsibility. Without electricity, educating children is difficult; families must heat
their homes with coal or wood, a major cause of respiratory diseases; and new businesses and employment
opportunities can’t grow. Eskom receives 80 percent of
its revenues from industrial customers, but the company
also has a self-imposed mission: to deliver electricity to
all individuals, especially those who, in every sense, have
lived without power.
Eskom adopted this mandate not in the wake of
apartheid’s fall, but in the mid-1980s, when it was legally
prohibited from providing electricity to black communities. The company’s early embrace of “electricity for all”
(as the policy is called) allowed the company to play a
leadership role early on in the social transformation of
South Africa. Not only did the company rethink the value
of serving black customers and remake its work force
to bring blacks into positions of responsibility—both in
defiance of the laws then in place—but it thus positioned
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
itself as one of the very few African companies that
could make a play for international expansion. (South
African Breweries, now SABMiller, is another.)
Ahead of Change
“One cannot manage change,” wrote noted management
author Peter Drucker. “One can only be ahead of it.” That
maxim could be Eskom’s motto. By preparing in advance
for the end of apartheid, risking its own executives’ lives
in the process, the company established a pivotal role for
itself in the South African economy, and arguably in its
culture as well. Eskom’s story is the sort often recounted
under the banner of corporate social responsibility, but
the company’s efforts were not primarily motivated by
the desire for a good reputation. They had much
W more to
do with resilience and growth as an enterprise.
Eskom’s leaders take the position that Ibecause no
business can perform to its full potential in aLsociety that
is failing, companies must be involved in the societal
S needs
health of their country. “It’s not only that society
strong and sustainable businesses. Businesses
O need
sustainable societies in which to operate,” says Wendy
N
Poulton, Eskom’s general manager of corporate sustain, as a busiability. “Our view is if you don’t recognize this
ness, you’re going to be out of business.”
Since the inception of “electricity for all,” Eskom has
J homes
electrified an average of 300,000 additional
annually. In 2006, Eskom reported delivering
A electricity
to 3.3 million homes, compared to only 120,000 during
M cation
the last years of apartheid. To be sure, this electrifi
rate lags behind those of other emergingI economies,
such as India and China, but it means that 66 percent of
E is up from
the South African public has electricity, which
30 percent a decade ago. This rate is more than four
times the percentage in the rest of sub-Saharan Africa.
5 in 20 subWith wholly owned electric power operations
Saharan countries and partnerships in 10 others,
0 Eskom
is also trying to be an economic engine for all of Africa—
5
intending to bring electricity to more than a billion
people, many of whom still live by candles and
1 kerosene
lamps. Currently, Eskom is among the largest utilities
B
in the world, ranking 11th in generation capacity and
U report.
seventh in sales, according to its 2005 annual
Electricity sales reached R36.6 billion (US$4.61 billion),
with pretax profits of R4.6 million (US$579,710) in the
2005–06 fiscal year.
Throughout its history, Eskom has had to manage
the complex relationship among South Africa’s government, financial, and industrial sectors. The utility traces
117
its origins to private entrepreneurs at the beginning of
the 20th century who won the first concessions to transmit electricity to the newly discovered gold deposits of
the Witwaterstrand, the mountain range in northeastern
South Africa that now houses the richest gold mines
on earth. In 1910, when the Union of South Africa was
formed, the Transvaal provincial government, representing the heart of the mining region, declared that supplying electricity was too important a public service to
leave in private hands. In 1923, when apartheid was still
a relatively informal policy in the country, the Electricity
Supply Commission, abbreviated to Escom (the spelling
was later changed), was created to absorb and run South
Africa’s electricity assets, with no profit requirement.
Escom was one of the first parastatals—South Africa’s
state corporations. Together with Iscor, which produces
iron and steel; Sasol, which refines liquid fuels and other
products from coal; and Foskor, which mines phosphate,
Escom provided the infrastructure and raw materials to
grow South Africa’s economy. The parastatals also provided critical support to the government’s increasingly
separatist regime. After 1948, when apartheid became
national policy, the government and therefore Escom
effectively wrote off most black townships, arguing that
their inhabitants would one day return to the so-called
homelands. This homeland policy, or “grand apartheid,”
inhibited investment in township infrastructure, schools,
and other basic services. However, the demand for electricity increased among the white population—enough to
drive Escom to expand its generating capacity dramatically in the 1960s and early ’70s.
When the utility made plans to erect five coal-fired
power stations, Dr. Ian McRae, then the head of power
station operations, saw a large problem ahead: a shortage of white workers with the skills needed to staff
those plants. “We realized we had all these new power
stations coming on and we didn’t have the people to
operate them,” recalls Dr. McRae.
His solution was to begin training blacks to fill these
positions, even though most were illiterate and apartheid
outlawed them from being anything more than unskilled
laborers. At the time, the laws reserved certain jobs for
whites, and white trade unions jealously guarded those
rules. (Black trade unions were illegal until 1979.) Breaking
the law, though, wasn’t what most concerned Dr. McRae;
rather, he worried whether Escom’s employees would
support such radical measures. So he set up meetings at
each power station with trade union representatives, plant
managers, and black laborers to discuss the idea of blacks’
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
118
Chapter 5
doing jobs traditionally performed by whites. Reassured
that there would be minimal resistance, Dr. McRae started
introducing blacks into the ranks in the new position of
“operating assistant” and providing them with the training to develop their technical skills. He removed the existing educational barriers so that nonwhite operators could
move into the position of shift supervisor. “I got people to
agree that a good operator, with some experience, could
move up,” says Dr. McRae.
By the late 1970s, worldwide condemnation of apartheid had left South Africa isolated, and its economy
was stagnating. Demand for power plummeted, and
it soon became clear that the power stations Escom
had committed to build were no longer needed. After
W
the company jacked up prices to offset the costs of
construction and operational misfires, it found itselfIin
financial difficulty.
L
That’s when the government stepped in. In May
S
1983, a commission appointed by the Minerals and
Energy Ministry and led by mining executive W.J. O
de
Villiers found fault with Escom’s management of foreN
casting, governance, accounting, and investment. Amid
,
the commission’s inquiry, a scandal broke concerning
a company accountant who had defrauded Escom of
nearly $4 million; he was convicted and the finance
J
chief was forced to resign. Escom was now a national
embarrassment. The De Villiers Commission replaced
A
its existing hierarchy with a new two-tier governance
M
structure. An Electricity Council, appointed by and
reporting to the government, represented the stakeI
holders, including consumers and unions, and set
E
policy. Below that was the management board, which
ran the company. For the first time, Escom would be
accountable for profits and losses.
5
In 1984, the De Villiers Commission nominated
Dr. McRae to be Escom’s chief executive. For chairman
0
of the new management board, South African President
5
P.W. Botha chose Dr. John B. Maree. The two men, tem1
peramentally quite different, took on financial and cultural
reforms together. Dr. McRae was the consummate comB
pany man. Soft-spoken and professorial in demeanor,
he had started at Escom as an artisan’s apprentice U
in
1947. He was well-liked and respected inside the company and in the industry. Dr. Maree, a turnaround specialist, was renowned for his shrewd political instincts and
his blunt management style. A former divisional chair
at Barlows Ltd., one of the country’s oldest and largest
conglomerates, Dr. Maree came to Escom following a
three-year stint as the chief executive of Armscor, South
Africa’s defense parastatal.
Drs. McRae and Maree began by looking inward. Using
Dr. McRae’s signature “walkabouts,” a technique he had
developed years earlier to make sure he never lost touch
with his employees, they met with small groups of senior
and middle managers in regional offices, power stations,
and distribution and service departments. Morale was
low. Consumer criticism had hurt, and Escom-bashing in
the press made it worse.
At the head office, the two assembled Escom’s best
and brightest managers and strategic thinkers into a
senior management council they called the “Top 30.” A
few outsiders were also invited, including Reuel J. Khoza,
a management consultant recognized for his entrepreneurial acumen and commitment to social change. (In
1997, he would become Eskom’s first black chairman.)
Escom’s leaders defined their most pressing task as
fixing the fiscal mess and turning Escom into one of the
world’s top utilities. “John and I knew our performance
had to be first class, or the government would take over,”
remembers Dr. McRae. “I had seen all over Africa how
disastrous such political interference could be. We had
to keep the government out of the engine room.”
Electricity for All
Downsizing was a critical step—and a move unheard of at
Escom. Over the years, Escom had developed a reputation
as an undemanding workplace. People joked that Escom
stood for “easy, slow, comfortable.” Dr. Maree pushed
through instant work-force reductions from 66,000 to
60,000. By 1995 the head count was 39,000. (Today
it’s just under 30,000.) A name change from Escom to
Eskom symbolically cemented the shift and distanced
the company from its former identity as the government’s
supply commission.
While Dr. Maree drove the company to higher performance, Dr. McRae started to champion the vision of “electricity for all”—a response to the change he believed was
inevitable. “South Africa was facing political transition,
either through armed struggle or political negotiation,” he
wrote in his memoir, The Test of Leadership (EE Publishers,
2006). “When (not if) the ANC came into power, Eskom
needed to be performing to the satisfaction of everyone in
our country and that included making electricity available
to all, not just one third of the population.”
Dr. McRae proposed that Eskom begin offering
electricity directly to households in the townships.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
The Organization
Other executives agreed, but saw his plan as too risky,
politically and financially. They weren’t convinced blacks
really wanted electricity; the few who could afford it complained of poor service and exorbitant bills. Furthermore,
there was no commercial logic for growing a customer
base of poor households, especially because at the time
it was still illegal for Eskom to do so.
“To me the threat of not getting people electricity was
greater,” recalls Dr. McRae. “In these urban townships,
there was no commercial or industrial infrastructure.
What really worried me wasn’t the lack of electricity; it
was poverty.”
Before pressing for further support within the company, he decided to see for himself if there was market
demand. At great personal risk, he went to
Wtownships,
where few whites had ever ventured, to ask residents
directly whether they wanted electricity, Iand if they
would pay for Eskom’s service. With the helpLof the thenbanned ANC, he met at night with people in churches
SDr. McRae
and in their homes. On one visit to Soweto,
learned why the bills were so high: Meters O
were locked
in cubicles on the sidewalks and were not read regularly.
N
“When I went to those meetings, I got a clear signal that
,
they did want electricity if the price was reasonable
and
they could get decent service,” he says.
To buttress his argument, he pointed to the favelas of
J are similar
Rio de Janeiro. In these squatter cities, which
to South Africa’s shantytowns, the residentsA
were eager
to buy electricity when delivery was reliable. Dr. McRae
won the support of Eskom’s board, and M
in 1989, he
launched a drive to bring affordable, safe Ielectricity to
the townships.
To achieve that goal, the utility had E
to devise a
completely new way to collect payment. There was no
postal service, and most residents had no fixed address
5 up with a
and did not hold regular jobs. Eskom came
revolutionary prepayment system that is still
0 in use; an
inhome metering system that changed the dynamics of
5
the black political struggle—withholding payment was a
frequent form of protest—and forever altered
1 the business model of Eskom. The in-home system used fare
B
cards purchased at the post office; customers inserted
U flow. Four
them into the meter to activate the electricity
lights in the meter box allowed residents to monitor how
much electricity they had left. The system also helped
residents and the company avoid a mishap that both
hated: service disconnections for nonpayment. Township
activists continued to play an advocacy role; for example,
they pressed for the replacement of unreliable meters.
119
Meanwhile, as Dr. McRae recalls, new stories of township entrepreneurialism emerged. A man who had baked
his family’s bread over an open fire invested in two electric ovens, which he used to start a successful bakery
business that grew to have seven employees. A skilled
welder launched a business with two other men making
fencing, security bars for windows, and small steel chairs.
Successes like these were the clearest vindication of
Eskom’s prescience.
Equalizing Opportunity
As the company worked to desegregate power delivery,
its leaders attacked segregation inside Eskom. Dr. Maree
recalls becoming committed to the idea when the company opened its Matimba power station, near the
Botswana border, in 1987. “I’ll never forget one man who
came up to me and said, ‘Dr. Maree, electricity has no
color. Eskom should not have color.’ That really hit me.” To
be a top-performing utility, he and Dr. McRae declared,
Eskom had to fast-track development of the staff from
all races. They also argued that Eskom would better
serve black customers if black workers at Eskom held
positions of authority.
Integration was painful, especially for middle managers. “I remember sending young engineers, one black
and one white, to the power stations,” says Dr. Steve
Lennon, who was then a middle manager and is now
Eskom’s managing director of resources and strategy.
“They were expected to work together, but they weren’t
allowed to sleep in the same place. I had a fight with
one station manager, and ended up transferring a black
scientist to another project because of the segregation.”
At the same time, it was Eskom’s social progressiveness
and its growing reputation for technical excellence that
attracted highly skilled individuals like Dr. Lennon in the
first place.
And it also attracted those few black students who
had beaten the odds to become engineers. When Ehud
Matya graduated from engineering school in 1986, he
committed to a four-year stint with Eskom. He had been
the first black at his school to win an Eskomsponsored
scholarship, and Eskom had gone out on a limb to award
it to him. Assigned to a team piloting a software system
at Duvha Power Plant, the largest in the world, he broke
the managerial color barrier. Yet lavatories and lunchrooms were still closed to him. Before the year was over,
he left Eskom for a job at South African Breweries. “The
race issues were more challenging than I had expected,”
he says.
9781111219802, Strategic Management: Theory and Practice, John Parnell - © Cengage Learning
120
Chapter 5
Dr. Mare...
Purchase answer to see full
attachment