Ethics and the Conduct of Business John R. Boatright Seventh Edition

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ISBN 978-1-29202-286-4

Ethics and the Conduct of Business

John R. Boatright

Seventh Edition

Ethics and the Conduct of Business Boatright Seventh Edition

Ethics and the Conduct of Business

John R. Boatright

Seventh Edition

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ISBN 10: 1-292-02286-8

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Table of Contents

PEARSON C U S T OM LIBRAR Y

. Ethics in the World of Business

1John R. Boatright

. Ethical Decision Making

23John R. Boatright

. Ethical Theories

53John R. Boatright

. Whistle Blowing

77John R. Boatright

. Trade Secrets and Conflict of Interest

97John R. Boatright

. Privacy

121

121John R. Boatright

. Discrimination and Affirmative Action

145

145John R. Boatright

. Employment Rights

175

175John R. Boatright

. Occupational Health and Safety

205

205John R. Boatright

. Marketing, Advertising, and Product Safety

227

227John R. Boatright

. Ethics in Finance

261

261John R. Boatright

. Corporate Social Responsibility

289

289John R. Boatright

. Corporate Governance and Accountability

315

315John R. Boatright

345

345Index

Ethics in the World of Business

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CASE 1

Merck and the Marketing of Vioxx

On September 30, 2004, Merck & Co. announced the withdrawal of Vioxx, its highly profitable

pain reliever for arthritis sufferers, from the market.

This announcement came only seven days

after company researchers found in a clinical trial that subjects who used Vioxx more than

18 months had a substantially higher incidence of heart attacks. Merck chairman and CEO

Raymond V. Gilmartin described the action as “the responsible thing to do.” He explained, “It’s

built into the principles of the company to think in this fashion. That’s why the management

team came to such an easy conclusion.”

In the lawsuits that followed, however, damaging

documents emerged casting doubt on Merck’s claim that it had acted responsibly by taking

appropriate precautions in the development and marketing of the drug.

For decades, Merck’s stellar reputation rested on the company’s emphasis on science-driven

research and development. Merck employed some of the world’s most talented and best-paid

researchers and led other pharmaceutical firms in the publication of scientific articles and the

discovery of new medicines for the treatment of serious conditions that lacked a satisfactory

treatment. For seven consecutive years in the 1980s, Merck was ranked by Fortune magazine as

America’s most respected company. Merck received widespread accolades in particular for the

decision, made in 1978, to proceed with research on a drug for preventing river blindness

(onchocerciasis), which is a debilitating parasite infection that afflicts many in Africa, even though

the drug was unlikely to pay for itself. Eventually, Merck decided to give away the drug, called

Mectizan, for as long as necessary at a cost of tens of millions of dollars per year. This kind of

principled decision making was inspired by the words of George W. Merck, the son of the

company’s founder: “We try never to forget that medicine is for the people. It is not for the profits.

The profits follow, and if we have remembered that, they have never failed to appear. The better we

have remembered it, the larger they have been.”

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Ethics in the World of Business

Vioxx is an example of Merck’s innovative research. Developed as a treatment for the pain of

arthritis, the drug acts as an anti-inflammant by suppressing an enzyme responsible for arthritis

pain. Other drugs in the class of nonsteroidal anti-inflammatory drugs (NSAIDs) inhibit the

production of two enzymes COX-1 and COX-2. However, COX-1 is important for protecting

the stomach lining, and so ulcers and stomach bleeding are potential side effects of these drugs.

The distinctive benefit of Vioxx over other NSAID pain relievers, such as ibuprofen (Advil) and

naproxen (Aleve), is that it inhibits the production of only the COX-2 enzyme, and not COX-1.

After approval by the Food and Drug Administration (FDA) in May 1999, Vioxx quickly became

a popular best seller. More than 20 million people took Vioxx between 1999 and 2004, and at the

time of the withdrawal, with 2 million users, Merck was earning $2.5 billion annually or 11 percent

of the company’s total revenues from the sale of the drug.

The success of Vioxx came at a critical time for Merck. Not only were the patents on several

profitable drugs due to expire, opening the way for generic competition, but also the competitive

environment of the entire pharmaceutical industry was undergoing rapid change. Competition

from generic drugs increased dramatically due to federal legislation and also due to the rise of

large, powerful managed care organizations, which sought to cut the cost of drug treatments

through the use of formularies that restricted the drugs doctors could prescribe. The development

of new drugs was increasingly shifting to small entrepreneurial research companies focused on

specific technologies, which reduced the competitive advantage of the traditional large pharma-

ceutical firms. Merck’s competitors responded to changes in the competitive environment by

acquiring small companies, developing new products that duplicated ones already on the market

(so-called “me-too” drugs), entering the generics market, seeking extensions of patents after

making only slight improvements, and engaging in aggressive marketing, including the use of

controversial direct-to-consumer (DTC) advertising.

The first four strategies—growth by acquisition, the development of “me-too” drugs,

the production of generics, and making improvements merely to extend patents—conflicted

with Merck’s culture and values. However, under the previous CEO, Roy Vagelos (who guided

Merck through the development of Mectizan for river blindness), the company greatly

increased its emphasis on marketing. This emphasis was considered necessary given the short

time available to sell a drug before the patent expired. In particular, evidence was needed not

only to prove a product’s safety and effectiveness in order to gain FDA approval but also to

persuade physicians to prescribe it instead of the competitors’ medications. Since much of

the information that could persuade doctors was part of a drug’s label, marketers needed to be

involved in the development of a product from the earliest research stages in order to prepare

a persuasive label. The label could be improved further by conducting tests which were not

scientifically necessary but which generated clinically proven results that could be useful in

persuading physicians. Under Gilmartin, the company’s formally stated strategy became:

“Turning cutting-edge science into novel medicines that are true advances in patient care with

proven clinical outcomes.”

In announcing the withdrawal of Vioxx, Gilmartin described the evidence of increased risk

of heart attacks as “unexpected.” In the first lawsuits against Merck that came to trial, evidence

was presented to show that company scientists had considered the potential heart problems with

Vioxx as early as 1997. The first hint of trouble came in that year as Merck scientists noticed that

Vioxx appeared to suppress the production of a substance in the body that acted naturally to

reduce the incidence of heart attacks. Although the significance of this discovery was recognized,

no follow-up investigations were undertaken.

More significant evidence that Vioxx might contribute to heart attacks was produced by

a study concluded in 2000 that was designed to compare the gastrointestinal effects of Vioxx and

naproxen in order to improve the label of the Merck product by proving that Vioxx was less

harmful to the stomach lining. Although the study, called VIGOR (for Vioxx Gastrointestinal

Outcomes Research), showed that Vioxx users had heart attacks at a rate four to five times that of

the naproxen group, researchers were uncertain whether the difference was due to an adverse

Ethics in the World of Business

effect of Vioxx in causing heart attacks or a beneficial effect of naproxen in preventing them.

The heart attacks in the trial occurred mainly in the Vioxx subjects already at greatest risk of heart

attacks, and all subjects were prohibited from taking aspirin (which is known to prevent

heart attacks) in order to gain reliable results from the study since aspirin affects the stomach.

When the results of the VIGOR study were published in November 2000 in the prestigious New

England Journal of Medicine, the beneficial effects of naproxen were emphasized in a way that

implied that Vioxx was safe for people without the risk factors for heart attacks. After initially

resisting pressure by the FDA to include a warning on the Vioxx label, Merck finally agreed in

April 2002 to add the evidence of an increased incidence of heart attacks. However, the language

on the label emphasized, again, the uncertainty of the cause and recommended that people at risk

of heart attacks continue to use an anti-inflammant for protection.

In the meantime, Merck continued its aggressive marketing campaign. Between 1999 and

2004, Merck spent more than $500 million on DTC television and print advertising. This

expenditure was intended to keep pace with the heavy spending by Pfizer for its competing

COX-2 inhibiter Celebrex. Merck also maintained a 3000-person sales force to meet with

doctors for face-to-face conversations about Vioxx. To support this effort, Merck developed

materials that provided salespeople with responses to questions from skeptical physicians.

One document, called an “obstacle handling guide,” advised that questions about the risk of

heart attacks be answered with the evasive explanations that Vioxx “would not be expected to

demonstrate reductions” in heart attacks and was “not a substitute for aspirin.” Another docu-

ment titled “Dodge Ball Vioxx” concluded with four pages that were blank except for the word

“DODGE!” in capital letters on each page. Company documents also describe an effort to

“neutralize” skeptical doctors by enlisting their support or at least defusing their opposition by

offers of research support or engagements as consultants.

The study that conclusively established that Vioxx increased the risk of heart attacks was

called APPROVe (Adenomatous Polyp Prevention on Vioxx), which, according to critics, had

only a marketing and not a legitimate scientific purpose.

Although the company could have de-

layed the withdrawal until ordered to do so by the FDA, Merck acted voluntarily. Gilmartin said

that the company “was really putting patient safety first.”

However, one critic replied, “If Merck

were truly acting in the interest of the public, of course, they should have done more studies on

Vioxx’s safety when doubts about it first surfaced.”

Another critic observed that such studies

could have been conducted for a fraction of the cost of the $500 million spent on advertising.

editorial in the New York Times declared that “companies must jump at the first hint of risk and

warn patients and doctors of any dangers as clearly and quickly as possible. They should not be

stonewalling regulators, soft-pedaling risk to doctors or promoting drugs to millions of people

who don’t need them.”

A 179-page report commissioned by the Merck board concluded, by

contrast, that executives and researchers acted with integrity in addressing incomplete and

conflicting evidence and that “their conclusions were reached in good faith and were reasonable

under the circumstances.”

The report closed with the observation that the quick response after

the APPROVe study “is not consistent with the view that Merck’s corporate culture put profits

over patient safety.”

INTRODUCTION

The Vioxx crisis was an unusually difficult and damaging experience for Merck, which has both

a history of responsible conduct and a commitment to the highest standards of ethics. Although

Merck’s culture is built on strong values, these were not enough to prevent a series of decisions

that, right or wrong, seriously damaged the company’s carefully built reputation. Merck

executives appear to have considered carefully the possible health risk posed by Vioxx, and yet

the push for profits may have led them to conclude too easily that Vioxx was not the cause of the

Ethics in the World of Business

heart attacks suffered by test subjects and that further studies were not necessary. The increased

role of marketing, including heavy consumer advertising, in a traditionally science-driven culture

was probably a factor in whatever mistakes were made, as was the change in strategy to seek

evidence of the products’ superiority as part of a marketing campaign to influence physicians.

However, Merck’s strategy could not avoid some adjustment given the changed competitive

environment that was created by forces outside the company’s control.

All business organizations face the daunting challenge of adhering to the highest stan-

dards of ethics while, at the same time, remaining competitive and providing the products

and services that the public demands. The task of managers in these organizations is to make

sound business decisions that enable a company to achieve its mission. Some of these

decisions involve complex ethical issues that may not be readily apparent, and success in mak-

ing sound business decisions may depend on understanding these ethical issues and resolving

them effectively. This text is about the ethical issues that arise for managers—and, indeed, for

all people, including employees, consumers, and members of the public. Corporate activities

affect us all, and so the ethical conduct of business is a matter of concern for everyone. The

ethical issues examined in this text are those considered by managers in the ordinary course of

their work, but they are also matters that are discussed in the pages of the business press, de-

bated in the halls of Congress, and scrutinized by the courts. This is because ethical issues in

business are closely tied to important matters of public policy and to the legislative and

judicial processes of government. They are often only part of a complex set of challenges fac-

ing the whole of society.

BUSINESS DECISION MAKING

Although ethical issues in business are very diverse, the following examples provide a useful

starting point.

1. The Sales Rep. A sales representative for a struggling computer supply firm has a

chance to close a multimillion-dollar deal for an office system to be installed over a two-year

period. The machines for the first delivery are in the company’s warehouse, but the remainder

would have to be ordered from the manufacturer. Because the manufacturer is having difficulty

meeting the heavy demand for the popular model, the sales representative is not sure that sub-

sequent deliveries can be made on time. Any delay in converting to the new system would be

costly to the customer; however, the blame could be placed on the manufacturer. Should the

sales representative close the deal without advising the customer of the problem?

2. The Research Director. The director of research in a large aerospace firm recently

promoted a woman to head an engineering team charged with designing a critical component for

a new plane. She was tapped for the job because of her superior knowledge of the engineering

aspects of the project, but the men under her direction have been expressing resentment at work-

ing for a woman by subtly sabotaging the work of the team. The director believes that it is unfair

to deprive the woman of advancement merely because of the prejudice of her male colleagues,

but quick completion of the designs and the building of a prototype are vital to the success of the

company. Should he remove the woman as head of the engineering team?

3. The Marketing Director. The vice president of marketing for a major brewing company

is aware that college students account for a large proportion of beer sales and that people in this

age-group form lifelong loyalties to particular brands of beer. The executive is personally uncom-

fortable with the tasteless gimmicks used by her competitors in the industry to encourage

drinking on campuses, including beach parties and beer-drinking contests. She worries about the

company’s contribution to underage drinking and alcohol abuse among college students. Should

she go along with the competition?

Ethics in the World of Business

4. The CEO. The CEO of a midsize producer of a popular line of kitchen appliances is

approached about merging with a larger company. The terms offered by the suitor are very

advantageous to the CEO, who would receive a large severance package. The shareholders of the

firm would also benefit, because the offer for their stock is substantially above the current market

price. The CEO learns, however, that plans call for closing a plant that is the major employer in

a small town. The firm has always taken its social responsibility seriously, but the CEO is now

unsure of how to balance the welfare of the employees who would be thrown out of work and

the community where the plant is located against the interests of the shareholders. He is also not

sure how much to take his own interests into account. Should he support a merger that harms the

community but benefits the shareholders and himself?

These four examples give some idea of the ethical issues that arise at all levels of business.

The individuals in these cases are faced with questions about ethics in their relations with

customers, employees, and members of the larger society. Frequently, the ethically correct course

of action is clear, and people in business act accordingly. Exceptions occur, however, when there is

uncertainty about ethical obligations in particular situations or when considerations of ethics

come into conflict with the practical demands of business. The sales representative might not be

sure, for example, about the extent to which he is obligated to provide information about possi-

ble delays in delivery. And the director of research, although convinced that discrimination is

wrong, might still feel that he has no choice but to remove the woman as head of the team in

order to get the job done.

In deciding on an ethical course of action, we can rely to some extent on the rules of right

conduct that we employ in everyday life. Deception is wrong, for example, whether we deceive a

friend or a customer. And corporations no less than persons have an obligation not to discriminate

or cause harm. However, business activity also has some features that limit the applicability of our

ordinary ethical views. In business settings, we encounter situations that are significantly different

from those of everyday life, and business roles place their own obligations on us. For example, the

CEO, by virtue of his position, has responsibilities to several different constituencies, and his

problem in part is to find the proper balance.

Two Distinguishing Features

One distinguishing feature of business is its economic character. In the world of business, we

interact with each other not as family members, friends, or neighbors, but as buyers and sellers,

employers and employees, and the like. Trading, for example, is often accompanied by hard

bargaining, in which both sides conceal their full hand and perhaps engage in some bluffing. And

a skilled salesperson is well versed in the art of arousing a customer’s attention (sometimes by

a bit of puffery) to clinch the sale. Still, there is an “ethics of trading” that prohibits the use of false

or deceptive claims and tricks such as “bait-and-switch” advertising.

Employment is also recognized as a special relationship, with its own standards of right

and wrong. Employers are generally entitled to hire and promote whomever they wish and to

lay off or terminate workers without regard for the consequences for the people affected. (This

right is being increasingly challenged, however, by those who hold that employers ought to fire

only for cause and to follow rules of due process in termination decisions.) Employees also

have some protections, such as a right not to be discriminated against or to be exposed

to workplace hazards. There are many controversies about the employment relationship, such

as the rights of employers and employees with regard to privacy and freedom of speech, for

example.

The ethics of business, then, is at least in part the ethics of economic or market activity,

such as the conduct of buyers and sellers and employers and employees. So we need to ask, what

are the ethical rules or standards that ought to govern these kinds of activities? And how do these

rules and standards differ from those that apply in other spheres of life?

Ethics in the World of Business

A second distinguishing feature of business is that it typically takes place in organizations.

An organization, according to organizational theory, is a hierarchical system of functionally

defined positions designed to achieve some goal or set of goals. Consequently, the members of

a business organization, in assuming a particular position, take on new obligations to pursue the

goals of the firm. Because business involves economic transactions and relationships that take

place in markets and also in organizations, it raises ethical issues for which the ethics of everyday

life has not prepared us. Although the familiar ethical rules about honesty, fairness, promise

keeping, and the like are applicable to business, it is necessary in many cases to rethink how they

apply in business situations. This is not to say that the ethics of business is different from ethics in

everyday life, but only that business is a different context, and it presents us with new situations

that require us to think through the ethical issues.

Levels of Decision Making

Decision making occurs on several distinct levels: the level of the individual, the level of the

organization, and the level of the business system. Situations that confront individuals in

the workplace and require them to make a decision about their own response are on the level of

individual decision making. An employee with an unreasonably demanding boss, for example, or

with a boss who is discovered padding his expense account faces the question: “What do I do?”

Whether to live with the difficult boss or to blow the whistle on the padding is a question to be

answered by the individual and acted on accordingly.

Many ethical problems occur at the level of the organization in the sense that the individ-

ual decision maker is acting on behalf of the organization in bringing about some organizational

change. Sexual harassment, for example, is an individual matter for the person suffering the

abuse, but a manager in an office where sexual harassment is happening must take steps not only

to rectify the situation but also to ensure that it does not occur again. The decision in this case

may be a disciplinary action, which involves a manager acting within his or her organizational

role. The manager may also institute training to prevent sexual harassment and possibly develop

a sexual harassment policy, which not only prohibits certain behavior but also creates procedures

for handling complaints. Responding to harassment as a manager, as opposed to dealing with

harassment as a victim, involves decisions on the organizational level rather than the individual

level. The question here is, “What do we as an organization do?”

Problems that result from accepted business practices or from features of the economic

system cannot be effectively addressed by any single organization, much less a lone individual. Sales

practices within an industry, for example, are difficult for one company to change single-handedly,

because the company is constrained by competition with possibly less-ethical competitors. The

most effective solution is likely to be an industry-wide code of ethics, agreed to by all. Similarly, the

lower pay for women’s work results from structural features of the labor market, which no one com-

pany or even industry can alter. A single employer cannot adopt a policy of comparable worth, for

example, because the problem is systemic, and consequently any substantial change must be on the

level of the system. Systemic problems are best solved by some form of regulation or economic

reform. On the systemic level, the relevant question is, “What do we as a society do?”

Identification of the appropriate level for a decision is important, because an ethical prob-

lem may have no solution on the level at which it is approached. The beer marketer described

earlier may have little choice but to follow the competition in using tasteless gimmicks because

the problem has no real solution on the individual or organizational level. An effective response

requires that she place the problem on the systemic level and seek a solution appropriate to that

level. Richard T. DeGeorge has described such a move as “ethical displacement,” which consists of

addressing a problem on a level other than the one on which the problem appears.

The fact that

some problems can be solved only by displacing them to a higher level is a source of great distress

for individuals in difficult situations, because they still must find some less-than-perfect response

on a lower level.

Ethics in the World of Business

CASE 2

The Ethics of Hardball

Toys “R”Us: Fair or Foul?

Hardball tactics are often applauded in business, but when Child World was the victim, the toy

retailer cried foul.

Its complaint was directed against a major competitor, Toys “R” Us, whose

employees allegedly bought Child World inventory off the shelves during a promotion in which

customers received $25 gift certificates for buying merchandise worth $100. The employees of Toys

“R” Us were accused of selecting products that Child World sold close to cost, such as diapers, baby

food, and infant formula. These items could be resold by Toys “R” Us at a profit, because the

purchase price at Child World was barely above what a wholesaler would charge, and then Toys “R”

Us could redeem the certificates for additional free merchandise, which could be resold at an even

higher profit. Child World claimed that its competitor bought up to $1.5 million worth of

merchandise in this undercover manner and received as much as $375,000 worth of gift certifi-

cates. The practice is apparently legal, although Child World stated that the promotion excluded

dealers, wholesalers, and retailers. Executives at Toys “R” Us did not deny the accusation and

contended that the practice is common in the industry. Child World may have left itself open to

such a hardball tactic by slashing prices and offering the certificates in an effort to increase market

share against its larger rival.

Home Depot: Good Ethics or Shrewd Business?

When weather forecasters predicted that Hurricane Andrew would strike the Miami area with full

force, customers rushed to stock up on plywood and other building materials.

That weekend

the 19 Home Depot stores in southern Florida sold more 4-foot-by-8-foot sheets of exterior

plywood than they usually sell in two weeks. On August 24, 1992, the hurricane struck, destroy-

ing or damaging more than 75,000 homes, and in the wake of the devastation, individual price

gougers were able to sell basics like water and food as well as building materials at wildly inflated

prices. But not Home Depot. The chain’s stores initially kept prices on plywood at pre-hurricane

levels, and when wholesale prices rose on average 28 percent, the company announced that it

would sell plywood, roofing materials, and plastic sheeting at cost and take no profit on the sales.

It did limit quantities, however, to prevent price gougers from reselling the goods at higher prices.

In addition, Home Depot successfully negotiated with its suppliers of plywood, including

Georgia-Pacific, the nation’s largest plywood producer, to roll back prices to pre-hurricane levels.

Georgia-Pacific, like Home Depot, has a large presence in Florida; the company runs 16 mills and

distribution centers in the state and owns 500,000 acres of timberland. Although prices increased

early in anticipation of Hurricane Andrew, Home Depot was still able, with the cooperation of

suppliers, to sell half-inch plywood sheets for $10.15 after the hurricane, compared with a price of

$8.65 before, thereby limiting the increase to less than 18 percent. Home Depot executives

explained their decision as an act of good ethics by not profiting from human misery. Others

contend, however, that the company made a shrewd business decision.

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ETHICS, ECONOMICS, AND LAW

Businesses are economic organizations that operate within a framework of law and regulation.

They are organized primarily to provide goods and services, as well as jobs, and their success

depends on operating efficiently and competitively. In a capitalist system, firms must compete

effectively in an open market by providing goods and services that customers want and by doing

so at a low price, which is possible only when the desired goods and services are produced

Ethics in the World of Business

efficiently. Profit is not the end or purpose of business, as is commonly asserted, but is merely the

return on the investment in a business that is possible only when the business is competitive.

Business has often been described as a game, in which the aim is to make as much profit as

possible while staying within the rules of the game, which are set mainly by government through

laws and regulations.

On this view, profit is a measure and the reward of success, but it cannot

be gained without also aiming to be competitive. Moreover, it is necessary, in pursuing profits, to

observe certain ethical standards, as well as laws and regulation, as a means to the end of profit

making.

Both economics and law are critical to business decision making, but the view that they are

the only relevant considerations and that ethics does not apply is plainly false. Even hard-fought

games like football have a code of sportsmanship in addition to a rule book, and business, too, is

governed by more than the legal rules. In addition, a competitive business system, in which every-

one pursues his or her self-interest, depends for its existence on ethical behavior and is itself

justified on ethical grounds. However, the relationships of business ethics to economics and the

law are very complicated and not easily summarized. The following discussion is intended to

clarify these relationships.

The Relationship of Ethics and Economics

According to economic theory, firms in a free market utilize scarce resources or factors of

production (labor, raw materials, and capital) in order to produce an output (goods and

services). The demand for this output is determined by the preferences of individual consumers

who select from among the available goods and services so as to maximize the satisfaction of their

preferences, which is called “utility.” Firms also seek to maximize their preferences or utility by

increasing their output up to the point where the amount received from the sale of goods and

services equals the amount spent for labor, raw materials, and capital—that is, where marginal

revenues equal marginal costs. Under fully competitive conditions, the result is economic

efficiency, which means the production of the maximum output for the least amount of input.

Economics thus provides an explanatory account of the choices of economic actors,

whether they be individuals or firms. On this account, the sole reason for any choice is to maxi-

mize utility. However, ethics considers many other kinds of reasons, including rights and justice

and other noneconomic values. To make a choice on the basis of ethics—that is, to use ethical

reasons in making a decision—appears at first glance to be incompatible with economic choice.

To make decisions on economic grounds and on ethical grounds is to employ two different kinds

of reasoning. This apparent incompatibility dissolves on closer inspection. If the economists’

account of economic reasoning is intended to be merely an explanation, then it tells us how we do

reason in making economic choices but not how we ought to reason. Economics as a science need

do no more than offer explanations, but economists generally hold that economic reasoning is

also justified. That is, economic actors ought to make utility-maximizing choices, which is an

ethical, and not merely an economic, judgment.

JUSTIFICATION OF THE MARKET SYSTEM. The argument for this position, that economic

actors ought to make utility-maximizing choices, is the classical defense of the market system. In

The Wealth of Nations, Adam Smith, the “father” of modern economics, justified the pursuit of

self-interest in exchange on the grounds that by making trades for our own advantage, we pro-

mote the interests of others. The justification for a free-market capitalist system is, in part, that

by pursuing profit, business firms promote the welfare of the whole society. Commentators on

Adam Smith have observed that this argument assumes a well-ordered civil society with a high

level of honesty and trust and an abundance of other moral virtues. Smith’s argument would

not apply well to a chaotic society marked by pervasive corruption and mistrust. Furthermore,

in his defense of the free market in The Wealth of Nations, Smith was speaking about exchange,

whereas economics also includes production and distribution.

The distribution of goods,

Ethics in the World of Business

for example, is heavily influenced by different initial endowments, access to natural resources, and

the vagaries of fortune, among other factors. Whether the vast disparities in wealth in the world are

justified is a question of distribution, not exchange, and is not addressed by Smith’s argument.

Moreover, certain conditions must be satisfied in order for business activity to benefit

society. These include the observance of minimal moral restraints to prevent theft, fraud, and the

like. Markets must be fully competitive, with easy entry and exit, and everyone must possess all

relevant information. In addition, all costs of production should be reflected in the prices that

firms and consumers pay. For example, unintended consequences of business activity, such as

job-related accidents, injuries from defective products, and pollution, are costs of production

that are often not covered or internalized by the manufacturer but passed to others as spillover

effects or externalities. Many business ethics problems arise when these conditions for the

operation of a free market are not satisfied.

SOME CONDITIONS FOR FREE MARKETS. A common view is that ensuring the conditions for

free markets and correcting for their absence is a job for government. It is government’s role, in

other words, to create the rules of the game that allow managers to make decisions solely on

economic grounds. However, the task of maintaining the marketplace cannot be handled by

government alone, and the failure of government to do its job may create an obligation for

business to help. Although government does enact and enforce laws against theft and fraud,

including such specialized forms as the theft of trade secrets and fraud in securities transactions,

there are many gray areas in which self-regulation and restraint should be exercised. Hardball

tactics like those allegedly employed by Toys “R” Us (Case 2) are apparently legal, but many com-

panies would consider such deliberate sabotage of a competitor to be an unacceptable business

practice that is incompatible with the market system.

Recent work in economics has revealed the influence of ethics on people’s economic

behavior. Economists have shown how a reputation for honesty and trustworthiness, for example,

attracts customers and potential business partners, thus creating economic opportunities that

would not be available otherwise. Similarly, people and firms with an unsavory reputation are

punished in the market. People are also motivated in their market behavior by considerations of

fairness. This is illustrated by the “ultimatum bargaining game,” in which two people are given a

certain amount of money (say $10) on the condition that one person proposes how the money is

to be divided (e.g., $5 to each) and the second person accepts or rejects the proposed division. The

first person can make only one proposal, and if the proposal is rejected by the second person, the

money is taken away and each person receives nothing. Economic theory suggests that the second

person would accept any proposal, no matter how small the share, if the alternative is no money at

all. Hence, the first person could offer to share as little as $1 or less. But many people who play the

game will refuse a proposal in which they receive a share that is considered too small and hence

unfair.

They would rather have nothing than be treated unfairly.

Economists explain the behavior of companies like Home Depot (Case 2) by the fact that

considerations of fairness force firms to limit profit-seeking behavior. Consumers remember

price gouging and other practices that they consider unfair and will punish the wrongdoers by

ceasing to do business with them or even by engaging in boycotts. One study found that people

do not believe that scarcity is an acceptable reason for raising prices (despite what economists

teach about supply and demand),

and so Home Depot and Georgia-Pacific, which are there for

the long haul, have more to lose than gain by taking advantage of a natural disaster. Evidence also

indicates that people in a natural disaster feel that everyone ought to make some sacrifice, so that

profit seeking by a few is perceived as shirking a fair share of the burden.

Finally, when economics is used in practice to support matters of public policy, it must be

guided by noneconomic values. Economic analysis can be applied to the market for cocaine as

easily as to the soybean market, but it cannot tell us whether we should allow both markets. That

is a decision for public-policy makers on the basis of other considerations. A tax system, for

example, depends on sound economic analysis, but the U.S. tax code attempts to achieve many

Ethics in the World of Business

aims simultaneously and to be accepted as fair. In drafting a new tax code, a demonstration that

a particular system is the most efficient from a purely economic perspective would not necessarily

be persuasive to a legislator who may also be concerned about considerations of fairness.

The Relationship of Ethics and the Law

Business activity takes place within an extensive framework of law, and some people hold that law

is the only set of rules that applies to business activity. Law, not ethics, is the only relevant guide.

The reasons that lead people to hold this view are varied, but two predominate.

TWO SCHOOLS OF THOUGHT. One school of thought is that law and ethics govern two

different realms. Law prevails in public life, whereas ethics is a private matter. The law is a clearly

defined set of enforceable rules that applies to everyone, whereas ethics is a matter of personal

opinion that reflects how we choose to lead our own lives. Consequently, it would be a mistake to

apply ethical rules in business, just as it would be a mistake to apply the rules of poker to tennis.

A variant of this position is that the law represents a minimal level of expected conduct that

everyone should observe. Ethics, on the other hand, is a higher, optional level. It’s “nice” to be

ethical, but our conduct has to be legal.

Both versions of this school of thought are mistaken. Although ethics does guide us in our

private lives, it is also applicable to matters in the public realm. We can identify business practices

as ethical or unethical, as, for example, when we say that discrimination or consumer fraud is

wrong. Moral judgments are also made about economic systems. Thus, most people believe that

capitalism is morally justified, although it has many critics who raise moral objections.

The other school of thought is that the law embodies the ethics of business. There are

ethical rules that apply to business, according to this position, and they have been enacted by

legislators into laws, which are enforceable by judges in a court. As a form of social control, law

has many advantages over ethics. Law provides more precise and detailed rules than ethics, and

the courts not only enforce these rules with state power but also are available to interpret them

when the wording is unclear. A common set of rules known to all also provides a level playing

field. Imagine the chaos if competing teams each decided for themselves what the rules of a game

ought to be. For these reasons, some people hold that it is morally sufficient in business merely to

observe the law. Their motto is, “If it’s legal, then it’s morally okay.”

In countries with well-developed legal systems, the law is a relatively complete guide for

business conduct. In the United States, much of what is unethical is also illegal. However, many

other countries of the world have undeveloped legal systems so that ethics, not law, provides the

main source of guidance. The relative lack of international law leaves ethics as an important guide

for global business. Moreover, no legal system can embrace the whole of morality. Ethics is needed

not only to address situations not covered by law but also to guide the creation of new law. The

1964 Civil Rights Act, for example, was passed by Congress in response to the recognition that

discrimination, which was legally practiced at the time, is morally wrong.

WHY THE LAW IS NOT ENOUGH. Despite their differences, these two schools of thought have

the same practical implication: Managers need to consider only the law in making decisions. This

implication is not only false but also highly dangerous. Regardless of the view that a practicing

manager takes on the relationship of law and ethics, reliance on the law alone is a prescription for

disaster, as many individuals and firms have discovered. Approval from a company’s legal

department does not always assure a successful legal resolution, and companies have prevailed in

court only to suffer adverse consequences in the marketplace. As a practical matter, then,

managers need to consider both the ethical and legal aspects of a situation in making a decision

for many reasons, including the following.

First, the law is inappropriate for regulating certain aspects of business activity. Not

everything that is immoral is illegal. Some ethical issues in business concern interpersonal

Ethics in the World of Business

relations at work or relations between competitors, which would be difficult to regulate by law.

Taking credit for someone else’s work, making unreasonable demands on subordinates, and

unjustly reprimanding an employee are all ethically objectionable practices, but they are best

left outside the law. Some hardball tactics against competitors may also be legal but ethically

objectionable. Whether the effort of Toys “R” Us to sabotage a promotion by its competitor is

acceptable behavior (see Case 2) is open to dispute, but not every legal competitive maneuver

is ethical. Generally, legislatures and the courts are reluctant to intervene in ordinary business

decisions unless significant rights or interests are at stake. They rightly feel that outsiders

should not second-guess the business judgment of people closer to a problem and impose

broad rules for problems that require a more flexible approach. Companies also prefer to

handle many problems without outside interference. Still, just because it is not illegal to do

certain things does not mean that they are morally okay.

Second, the law is often slow to develop in new areas of concern. Christopher D. Stone

points out that the law is primarily reactive, responding to problems that people in the business

world can anticipate and deal with long before they come to public attention.

The legislative

and judicial processes themselves take a long time, and meanwhile much damage can be done.

This is true not only for newly emergent problems but also for long-recognized problems where

the law has lagged behind public awareness. For example, sexual harassment was not recognized

as a legal wrong by the courts until 1977, and it took successive court decisions over two more

decades for the legal prohibition on sexual harassment to fully develop. At the present time, legal

protections for employees who blow the whistle and those who are unjustly dismissed are just

beginning to develop. Employers should not wait until they are forced by law to act on such

matters of growing concern.

Third, the law itself often employs moral concepts that are not precisely defined, so it is

impossible in some instances to understand the law without considering matters of morality. The

requirement of good faith, for example, is ubiquitous in law. The National Labor Relations Act

requires employers and the representatives of employees to bargain “in good faith.” One defense

against a charge of price discrimination is that a lower price was offered in a good-faith attempt

to meet the price of a competitor. Yet the notion of good faith is not precisely defined in either

instance. Abiding by the law, therefore, requires decision makers to have an understanding of this

key moral concept. Other imprecisely defined legal concepts are “fair dealing,” “best effort,” and

“due care.”

A fourth argument, closely related to the preceding one, is that the law itself is often unset-

tled, so that whether some course of action is legal must be decided by the courts. And in making

a decision, the courts are often guided by moral considerations. Many people have thought that

their actions, although perhaps immoral, were still legal, only to discover otherwise. The courts

often refuse to interpret the law literally when doing so gives legal sanction to blatant immorality.

Judges have some leeway or discretion in making decisions. In exercising this discretion, judges

are not necessarily substituting morality for law but rather expressing a morality that is embod-

ied in the law. Where there is doubt about what the law is, morality is a good predictor of how the

courts will decide.

Fifth, a pragmatic argument is that the law is a rather inefficient instrument, and an

exclusive reliance on law alone invites legislation and litigation where they are not necessary.

Many landmark enactments, such as the Civil Rights Act of 1964, the National Environment

Policy Act of 1969, the Occupational Safety and Health Act of 1970, and the Consumer Protection

Act of 1972, were passed by Congress in response to public outrage over the well-documented

failure of American businesses to act responsibly. Although business leaders lament the explosion

of product-liability suits by consumers injured by defective products, for example, consumers are

left with little choice but to use the legal system when manufacturers themselves hide behind “If

it’s legal, it’s morally okay.” Adopting this motto, then, is often shortsighted, and businesses may

often advance their self-interest more effectively by engaging in greater self-regulation that

observes ethical standards.

Ethics in the World of Business

ETHICS AND MANAGEMENT

Most managers think of themselves as ethical persons, but some still question whether ethics is

relevant to their role as a manager. It is important for people in business to be ethical, they might

say, but being ethical in business is no different than being ethical in private life. The implication

is that a manager need only be an ethical person. There is no need, in other words, to have

specialized knowledge or skills in ethics.

Nothing could be further from the truth. Although there is no separate ethics of business,

situations arise in business that are not easily addressed by ordinary ethical rules. We have already

observed that the obligation to tell the truth is difficult to apply to the dilemma faced by the sales

rep. In addition, the manager of a sales force might face the task of determining the rules of accept-

able sales practices for the whole organization and ensuring that the rules are followed. More

broadly, high-level managers have a responsibility for creating and maintaining an ethical corpo-

rate climate that protects the organization against unethical and illegal conduct by its members.

Furthermore, a well-defined value system serves to guide organizations in uncertain situations and

to gain acceptance of painful but necessary change.

Ethical Management and the Management of Ethics

A useful distinction can be made between ethical management and the management of ethics.

Business ethics is often conceived as acting ethically as a manager by doing the right thing. This is

ethical management. Acting ethically is important for both individual success and organizational

effectiveness. Ethical misconduct has ended more than a few promising careers, and some business

firms have been severely harmed and even destroyed by the actions of a few individuals. Major

scandals in the news attract our attention, but people in business face less momentous ethical

dilemmas in the ordinary course of their work. These dilemmas sometimes result from miscon-

duct by others, as when a subordinate is ordered to commit an unethical or illegal act, but they are

also inherent in typical business situations.

The management of ethics is acting effectively in situations that have an ethical aspect.

These situations occur in both the internal and external environments of a business firm.

Internally, organizations bind members together through myriad rules, procedures, policies, and

values that must be carefully managed. Some of these, such as a policy on conflict of interest or

the values expressed by a company's mission statement, explicitly involve ethics. Effective organi-

zational functioning also depends on gaining the acceptance of the rules, policies, and other

guides, and this acceptance requires a perception of fairness and commitment. For example, an

organization that does not “walk the talk” when it professes to value diversity is unlikely to gain

the full cooperation of its employees. With respect to the external environment, corporations

must successfully manage the demands for ethical conduct from groups concerned with racial

justice, human rights, the environment, and other matters.

In order to practice both ethical management and the management of ethics, it is necessary

for managers to possess some specialized knowledge. Many ethical issues have a factual back-

ground that must be understood. In dealing with a whistle-blower or developing a whistle-

blowing policy, for example, the managers of a company should be aware of the motivation of

whistle-blowers, the measures that other companies have found effective, and, not least, the

relevant law. In addition, many ethical issues involve competing theoretical perspectives that need

to be understood by a manager. Whether it is ethical to use confidential information about a

competitor or personal information about an employee depends on theories about intellectual

property rights and the right to privacy that are debated by philosophers and legal theorists.

Although a manager need not be equipped to participate in these debates, some familiarity with

the theoretical considerations is helpful in dealing with practical situations.

To make sound ethical decisions and to implement them in a corporate environment are skills

that come with experience and training. Some managers make mistakes because they fail to see the

Ethics in the World of Business

ethical dimensions of a situation. Other managers are unable to give proper weight to competing

ethical factors or to see other people’s perspectives. Thus, a manager may settle a controversial

question to his or her satisfaction, only to discover that others still disagree. Moral imagination is

often needed to arrive at creative solutions to problems. Finally, the resolution of a problem

usually involves persuading others of the rightness of a position, and so the ability to explain one’s

reasoning is a valuable skill.

The need for specialized knowledge and skills is especially acute when business is conducted

abroad.

In global business, there is a lack of consensus on acceptable standards of conduct,

and practices that work well at home may fare badly elsewhere. This is especially true in less-

developed countries with lower standards and weak institutions. How should a manager proceed,

for example, in a country with exploitive labor conditions, lax environmental regulations, and

pervasive corruption? Even the most ethical manager must rethink his or her beliefs about how

business ought to be conducted in other parts of the world.

Ethics and the Role of Managers

Every person in business occupies a role. A role is a structured set of relationships with accom-

panying rights and obligations. Thus, to be a purchasing agent or a personnel director or an

internal auditor is to occupy a role. In occupying a role, a person assumes certain rights that are

not held by everyone as well as certain role-specific obligations. Thus, a purchasing agent is

empowered to make purchases on behalf of an organization and has a responsibility to make

purchasing decisions that are best for the organization. To be a “good” purchasing agent is to do

the job of a purchasing agent well.

The obligations of a particular role are sometimes added to those of ordinary morality.

That is, a person who occupies a role generally assumes obligations over and above those of

everyday life. Sometimes, however, role obligations come into conflict with our other obligations.

In selecting people for promotion, a personnel director, for example, is obligated to set aside any

considerations of friendship and to be wholly impartial. A person in this position may also be

forced to terminate an employee for the good of the organization, without regard for the impact

on the employee’s life. A personnel director may even be required to implement a decision that he

or she believes to be morally wrong, such as terminating an employee for inadequate cause. In

such situations, the obligations of a role appear to be in conflict with the obligations of ordinary

morality.

Various justifications have been offered for role obligations. One justification is simply that

people in certain positions have responsibilities to many different groups and hence must consider

a wide range of interests. The decisions of a personnel director have an impact on everyone

connected with a business organization, and so denying a friend a promotion or terminating an

employee may be the right thing to do, all things considered. A more sophisticated justification is

that roles are created in order to serve society better as a whole. A well-designed system of roles, with

accompanying rights and obligations, enables a society to achieve more and thereby benefits

everyone. A system of roles thus constitutes a kind of division of labor. As in Adam Smith’s pin

factory, in which workers who perform specific operations can be more productive than individuals

working alone, so, too, a business organization with a multiplicity of roles can be more productive

and better serve society.

We cannot understand the role obligations of managers without knowing more about

their specific role. Managers serve at all levels of an organization—top, middle, and lower—

and fulfill a variety of roles. Usually, these are defined by a job description, such as the role of

a purchasing agent or a personnel director. Uncertainty arises mainly when we ask about the

role of top managers, that is, high-level corporate executives who make key decisions about

policy and strategy. The higher one goes in a business organization, the more roles one

occupies. Many of the ethical dilemmas for top managers are due to conflicts between three

main roles.

Ethics in the World of Business

1. Managers as Economic Actors. One inescapable requirement of the manager’s role is to

make sound economic or business decisions that enable a firm to succeed in a competitive

market. As economic actors, managers are expected to consider primarily economic factors in

making decisions, and the main measure of success is profitability. This is the goal of managers

who serve as economic actors even if they operate a sole proprietorship, a partnership, or any

other kind of business enterprise. However, as previously noted, ethical issues are intertwined

with business considerations in decision making, and the soundness of business decisions often

depends on the recognition of these ethical issues and their appropriate resolution.

2. Managers as Company Leaders. As leaders of business organizations, managers are

entrusted with enormous assets and given a charge to manage these assets prudently. Employees,

suppliers, customers, investors, and other so-called stakeholders have a stake in the success of

a firm, and managers are expected to meet all of their legitimate expectations and to balance any

conflicting interests. Corporations are also human communities in which individuals find not

only the means to support themselves but also personal satisfaction and meaning. Top managers,

in particular, serve these roles by building and maintaining a company’s culture, developing

a shared purpose and strategic vision, and, most importantly, meeting challenges and creating a

strong, enduring organization.

3. Managers as Community Leaders. Top managers of companies exert enormous power

both inside and outside their organizations. Although they are not elected in a democratic

process, they nevertheless have many attributes of government officials, such as the power to

make decisions that profoundly impact society. The CEO or chairman of a large corporation also

serves as an ambassador, representing the company in its relations with its myriad constituencies.

In any political system, such great power must be legitimized by showing how it serves some

generally accepted societal goals, and managerial power is no exception. So, top managers are

expected to demonstrate corporate leadership that serves the interests of society as a whole.

Many of the ethical dilemmas facing managers involve not merely a conflict between one’s

personal morality and the morality of a role but also a conflict between the moral demands of

different roles. For example, a manager may have to balance fairness to employees or a benefit to

the community against an obligation to act in the best interest of the company. Or a CEO may

find that he or she cannot easily serve both as a company leader and a community leader when

a decision must be made about a merger that would close a local plant. Some of the hardest

dilemmas in business ethics result from such role conflicts.

ETHICS IN ORGANIZATIONS

The manager who seeks to act ethically and to ensure the ethical conduct of others—which have been

identified in this chapter as “ethical management” and “the management of ethics”—must have the

ability not only to understand ethical issues and resolve them effectively but also to appreciate the

challenges of ethical decision making and ethical conduct in an organizational setting. The fact that

much business activity takes place in organizations has profound consequences for the manager’s

role responsibilities for several reasons.

First, much decision making in business is a collaborative endeavor in which each individ-

ual may play only a small role. Many organizational decisions get made without any one person

coming to a decision or being responsible for it. Second, this collaborative decision-making

process is subject to dynamic forces that may not be recognized or understood by any of the

participants. As a result, decisions get made that have consequences no one intended or expected.

Third, many organizational acts are not the result of any one person’s actions but are collective

actions that result from a multiplicity of individual actions. Many corporate acts are thus “deeds

without doers.”

Fourth, organizations themselves create an environment that may lead other-

wise ethical people to engage in unethical conduct. Organizational life, according to sociologist

Robert Jackall, poses a series of “moral mazes” which people must navigate at their own peril.

Ethics in the World of Business

Consequently, the typical case of wrongdoing in organizations involves missteps that are

due more to inadequate thought than deliberate malice, where people get tripped up in a moral

maze. The following two sections discuss the findings, mainly of psychologists and sociologists,

about how ethical mistakes result from flaws in individual decision making and from organiza-

tional forces.

Individual Decision Making

Wrongdoing is often attributed to the proverbial “bad apple,” the individual who knows that an

action is wrong but deliberately does it anyway. Such persons can be condemned for having a

bad character, and the lesson for others is to develop a good character. This is misleading both

as an analysis of the causes of bad conduct and as a prescription for ensuring good conduct. Of

course, there are bad apples, and they should not be hired or, if hired, should be let go once

their rottenness is known. This “bad apples” explanation is not very convincing, however, when

wrongdoing is committed by people we would identify as good employees or managers.

Moreover, when misconduct is widespread in an organization, as is often the case in major

scandals, it is not plausible to believe that dozens if not hundreds of people are all “bad apples.”

Some other explanations are needed, and fortunately psychologists and sociologists have

offered many.

First, many individuals work in environments in which they lack strong guidance and

receive conflicting signals.

Often there is strong pressure to follow orders and get the job done.

Barbara Toffler, who chronicled the last days of Arthur Andersen in a book, relates the tale of an

undergraduate who interned at a major accounting firm where he was ordered to make an

accounting entry that appeared to be irregular. When he told his superior, “This doesn’t look

right to me. Why am I doing it?” the reply was, “You’re doing it because I told you to do it.”

Employees who are told, “Just do it!” without more explicit instructions and without adequate

resources may perceive these words as an implicit order to do whatever it takes to get a job done.

Employees are also urged to be “team players” and go along with whatever is being done. Senior

managers, in giving orders, often prefer not to give detailed guidance, in part to avoid operational

responsibility (“Just do it, and don’t tell me how you got it done”). They also sometimes lack an

appreciation of the operational difficulties of a job and thus leave to subordinates the task of

solving problems their own ways.

Second, individuals are prone to rationalization and can often effectively persuade

themselves that a course of action is morally right or, at least, is not wrong under the circum-

stances. Saul Gellerman in the article “Why ‘Good’ Managers Make Bad Ethical Choices” identifies

four dangerous rationalizations.

• A belief that the activity is within reasonable ethical and legal limits—that is, that it is not

“really” illegal or immoral.

• A belief that the activity is in the individual’s or the corporation’s best interest—that the

individual would somehow be expected to undertake the activity.

• A belief that the activity is “safe” because it will never be found out or publicized; the

classic crime-and-punishment issue of discovery.

• A belief that because the activity helps the company, the company will condone it and even

protect the person who engages in it.

A particularly common rationalization in business is “everybody’s doing it.” This retort may even

justify some actions when refraining would put a company at a competitive disadvantage (when

competitors engage in deceptive advertising, for example) or when business cannot be conducted

without so acting (e.g., engaging in foreign bribery).

Other rationalizations include “No real

harm is done” or “No harm no foul”; “I deserve this” or “They owe this to me” (sometimes used

to justify pilfering); “It’s for a good cause” (the ends justify the means); and “If I don’t do this,

someone else will” (restraint is futile; the consequences will happen anyway).

Ethics in the World of Business

Sociologists who have studied crime, including the kind of white-collar crime that occurs

in business, have described a process of rationalization they call “neutralization” that enables

lawbreakers to deny the criminality of their behavior.

Among the techniques of neutraliza-

tion are claims that one is not really responsible (“I was out of my mind”), that any real harm

was done (“No one will miss that amount of money”), that the victim deserved the harm

(“I was only paying him back”), that one’s accusers are being unfair (“I’m being singled out for

blame”), and that one was following some higher duty or loyalty (“I had to protect my

friends”). All the rationalizations detailed here show the immense capacity of people to engage

in self-deception.

Third, psychologists have identified a number of features of human decision making that

produce errors of judgment.

Two of these researchers contend that “unethical business prac-

tices may stem not from the traditionally assumed trade-off between ethics and profits or from

a callous disregard of other people’s interest or welfare, but from psychological tendencies that

foster poor decision making, both from an ethical and a rational perspective.”

Some of these

“psychological tendencies” are biases that shift our decisions in one direction or another, while

others are heuristics or rule-of-thumb methods that we employ in reasoning.

Among the biases discovered by psychologists are the following:

• Loss Aversion Bias. People tend to weigh losses more heavily than gains and thus take

greater risks to avoid losing something they have than to gain something that they do not

have.

• Framing Effect. People’s decisions depend on how the choices are presented or framed.

Thus, the loss aversion bias leads people to choose alternatives that are framed in terms of

losses rather than gains.

• Confirmation Bias. This is the tendency of people to seek and process information that

confirms existing attitudes and beliefs instead of seeking and processing information that

poses challenges to their attitudes and beliefs.

• Cognitive Dissonance. Related to the confirmation bias, cognitive dissonance is the tendency

of people to dismiss information that would disrupt their existing attitudes and beliefs.

• Commitment and Sunk Costs. Once commitments are made and resources expended, people

tend to persist in a course of action, even in the face of information that should lead them to

reconsider their initial decision.

• Hindsight Bias. People tend to believe that events are more predictable than they are, and

consequently they blame themselves for not anticipating events that occur.

• Causation Bias and Illusion of Control. People often find causal patterns in random events,

which leads to the belief that they have a greater ability to control events than is warranted.

• Overoptimism and Overcofindence Bias. People are unduly confident of their own knowledge

and abilities and thus overestimate the likelihood of success.

• Self-interest Bias. People tend to make judgments, especially about fairness, that favor

themselves.

• Risk Perception Bias. People make poor judgments about risk, overestimating some risk and

discounting others, often ignoring low-probability events and favoring certain over uncertain

outcomes.

The main heuristics people employ are as follows:

• Anchoring and Adjustment Heuristic. People tend to form an initial choice (“anchor”) early

in the decision-making process and then adjust the choice in response to additional

information. Thus, the final decision is heavily influenced by the initial choice, especially

given that people often fail to make adequate adjustments.

• Representativeness Heuristic. This is the tendency of people to utilize recent and vivid examples

rather than objective statistical data. For example, a person purchasing an automobile may rely

on a friend’s experience with one model instead of reading test reports.

Ethics in the World of Business

• Availability Heuristic. People tend to make decisions based on the available information at

hand rather than seeking out new sources of information. Information may be “available,”

for example, because it is more recent or vivid or because it is easier or more comfortable to

remember.

These biases and heuristics have developed in the process of evolution to enable human

beings to decide and act quickly, especially in dangerous situations with too much informa-

tion to process fully. Generally, they serve us well but can lead to mistakes. They can cause us,

for example, to fail to consider important consequences or what could go wrong, to discount

the possibility of random events, to misidentify causes, to be overoptimistic or overconfident,

and to favor people like ourselves. Psychologists have also noted that biases and heuristics

prevent us from foreseeing disasters that we should have seen coming

and lead us to

overlook the unethical conduct of others.

Instances of defective products, accounting fraud,

and industrial accidents have been closely studied to reveal the psychological factors that

explain how such bad decisions could have been made by decent, diligent, well-intentioned

individuals.

Organizational Decision Making

When a company produces a defective product (e.g., Merck’s Vioxx or Toyota’s accelerator mech-

anism) or collapses from massive accounting fraud (as did Enron and WorldCom) or experiences

a major industrial accident (e.g., the Bhopal disaster), the fault generally lies with a series of

decisions that can be understood only by examining organizational factors. With the benefit of

hindsight, some mistaken decisions can often be found, but sometimes all of the decisions

involved seemed reasonable at the time. In such cases, the causes of major scandals and disasters

must be sought in the decision-making processes.

Decision making in organizations is marked by four features that contribute to mistakes,

big and small. First, major decisions are not made all at once with all their consequences and

ramifications understood; rather they are made over time in a series of small steps, no one of

which may raise any particular concerns. Second, as they are made over time, these multiple

decisions develop a commitment to a course of action that is usually difficult to stop. Once a

project is underway, there may be considerable sunk costs that cannot be recovered, and anyone

who proposes a halt to a project bears a burden of proof to justify it, whereas little justification

is needed to proceed with a project underway. Stopping a project also means that mistakes were

made, which it may be difficult for managers to admit since someone must bear the blame. With

commitment to a course of action also comes a psychological tendency to interpret evidence in

ways that support one’s beliefs and interests. This factor probably goes far toward explaining

why Merck executives misinterpreted the results of the VIGOR study and concluded that they

were due to the heart-protection benefit of naproxen and not to any harmful effect from Vioxx

(see Case 1).

The third and fourth factors are the most important: These are the diffusion of informa-

tion and the fragmentation of responsibility that occur in organizational decision making.

The information that would show that a product has a defect, for example, may exist within an

organization in an unassembled form in which different facts are known to different individu-

als. However, unless this information is assembled and made known to at least one person,

there may be no reason for anyone in the organization to conclude that a product is defective.

Furthermore, information is distributed in organizations on a need-to-know basis, and each

decision maker may have sufficient information for the decisions that that person makes. So

unless one individual is specifically charged with discovering defects, no decision maker would

typically have a reason to have access to all the information that would be necessary to reveal

adefect.

With diffusion of information comes fragmentation of responsibility. Each decision in

a series may be made by different individuals or groups, all of whom are discharging their

Ethics in the World of Business

specific responsibility and doing so well based on the information available to them. Thus,

a researcher testing a drug for its efficacy in treating a certain condition may assume that other

researchers have already proven its safety, so safety is not that researcher’s responsibility. And the

salespeople who pitch the drug to doctors assume that the researchers have done their job to test

its safety and efficacy; that is not their responsibility. In the end, when a drug is recalled, it may

be that no one is responsible since no one has failed in discharging his or her responsibility. It is

often said that “the buck stops at the top,” that the CEO or some other senior executive has a

responsibility to ensure, in this example, that a drug is safe, but that person is hostage to a host

of decisions made by others that he or she cannot fully assess. In such cases, only the organiza-

tion as a whole can be blamed or held responsible, and the only remedy to prevent a recurrence

is to improve the decision-making process within the organization.

Conclusion

Business ethics is concerned with identifying and understanding the ethical issues that arise in

business and with developing the knowledge and skills needed by a practicing manager to address

these issues and to make sound business decisions—that is, decisions that are sound from both

an ethical and a business perspective. Ethical issues are an inevitable element of business decision

making and are deeply intertwined with managerial practice and economic activity generally.

Business ethics is important for managers because the ethical issues examined here are involved

in many business decisions upon which the success of individual managers, business organiza-

tions, and, indeed, the whole economic system depend. Both economics and law are important

guides for business decision making, but, as this chapter has shown, they are not complete. Nor is

business ethics understood merely as the treatment of ethical issues from a philosophical per-

spective. As the work of psychologists and sociologists on organizational misconduct show, it is

not enough merely to determine a right course of action. Misconduct in organizations is also the

result of flaws in individual and organizational decision making that can be corrected only by

changes in decision-making processes. Although this text deals mainly with the treatment of eth-

ical issues in business, practicing managers must also address the larger challenge of preventing

misconduct within organizations.

CASE 3

Beech-Nut’s Bogus Apple Juice

When Lars Hoyvald joined Beech-Nut in 1981, the company was in financial trouble.

In the

competitive baby food industry, the company was a distant second behind Gerber, with 15 percent

of the market. After faltering under a succession of owners, Beech-Nut was bought in 1979 by

Nestlé, the Swiss food giant, which hoped to restore the luster of the brand name. Although he was

new to Beech-Nut, Hoyvald had wide experience in the food industry, and his aim, as stated on his

résumé, was “aggressively marketing top quality products.”

In June 1982, Hoyvald was faced with strong evidence that Beech-Nut apple juice for babies

was made from concentrate that included no apples. Since 1977, the company had been purchas-

ing low-cost apple concentrate from a Bronx-based supplier, Universal Juice Company. The price

alone should have raised questions, and John Lavery, the vice president in charge of operations,

brushed aside tests that showed the presence of corn syrup. Two employees who investigated

Universal’s “blending facility” found merely a warehouse. Their report was also dismissed by

Lavery. A turning point occurred when a private investigator working for the Processed Apple

Institute discovered that the Universal plant was producing only sugared water. After following a

truck to the Beech-Nut facility, the investigator informed Lavery and other executives of his

findings and invited Beech-Nut to join a suit against Universal.

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Ethics in the World of Business

CASE 4

KPMG’s Tax Shelter Business

In the 1990s, KPMG, one of the “big four” accounting firms, began offering tax shelters to corpo-

rations and wealthy investors. In addition to standard audit and consulting services, KPMG

aggressively developed and marketed a number of innovative ways for clients to avoid taxes. Not

only did individuals and businesses reduce taxes on billions of dollars of gains, but also KPMG

partners pocketed many millions for their assistance.

Acting like any business developing a new product, KPMG established a “Tax Innovation

Center” to generate ideas and to research the accounting, financial, and legal issues.

Previously, tax

shelters had been individualized for particular clients, but the new ones were intended to be generic,

mass-marketed products. Once a strategy was approved, it was energetically promoted to likely

clients by the firm’s sales force. KPMG tax professionals were turned into salespeople. They were

given revenue targets and urged to use telemarketing and the firm’s own confidential records to

locate clients. The strategies—which bore such acronyms as OPIS, BLIPS, FLIP, and SOS—generally

involved complicated investments with cooperating foreign and offshore banks that generated phan-

tom losses that could be used to offset capital gains or income from other investments. The shelters

were accompanied by opinion letters from law firms that assessed their legality. The gain to KPMG

and their clients and the loss to the U.S. Treasury were significant. The four main tax shelters

marketed by the firm generated over $11 billion in tax deductions for clients, which yielded at least

$115 million in fees for KPMG and cost the government $2.5 billion in lost tax revenue.

During the period in which the KPMG tax shelters were sold, no court or Internal Revenue

Service (IRS) ruling had declared them illegal. However, KPMG had failed to register the shelters

with the IRS as required by law. Registration alerts the tax authorities to the use of the shelters

and permits them to investigate their legality. One KPMG partner attributed this failure to a lack

of specific guidance by the IRS on the rules for registration and the agency’s lack of interest in

enforcing the registration requirement.

Furthermore, this partner calculated that for OPIS, the

firm would pay a penalty of only $31,000 if the failure to register were discovered. This amount

was more than outweighed by the fees of $360,000 for each shelter sold.

Until the courts or Congress explicitly outlaw a tax shelter, the line between legal and illegal

tax strategies is often difficult to draw. The IRS typically employs the “economic substance” test: Do

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Although some executives urged Hoyvald to switch suppliers and recall all apple juice on

the market, the president was hesitant. Even if the juice was bogus, there was no evidence that

it was harmful. It tasted like apple juice, and it surely provided some nutrition. Besides, he had

promised his Nestlé superior that he would return a profit of $7 million for the year. Switching

suppliers would mean paying about $750,000 more each year for juice and admitting that the

company had sold an adulterated product. A recall would cost about $3.5 million. Asked later

why he had not acted more decisively, Hoyvald said, “I could have called up Switzerland

and told them I had just closed the company down. Because that is what would have been the

result of it.”

Fearful that state and federal investigators might seize stocks of Beech-Nut apple juice,

Hoyvald launched an aggressive foreign sales campaign. On September 1, the company unloaded

thousands of cases on its distributors in Puerto Rico. Another 23,000 cases were shipped to the

Dominican Republic to be sold at half price. By the time that state and federal authorities had

forced a recall, the plan was largely complete. In November, Hoyvald reported to his superior at

Nestlé,“The recall has now been completed, and due to our many delays, we were only faced with

having to destroy approximately 20,000 cases.” Beech-Nut continued to sell bogus apple juice

until March 1983.

Ethics in the World of Business

the transactions involved in a tax shelter serve a legitimate investment objective or is their only

effect to reduce taxes? A tax shelter that offers no return beyond a tax saving is abusive in the view of

the IRS. However, an IRS ruling is not legally binding until it is upheld by the courts, and the courts

have occasionally held some shelters to be legal even if they do not involve any risk or potential

return. One reason for such decisions is that tax shelters typically involve legitimate transactions

combined in unusual ways. As one observer notes, “Most abusive shelters are based on legal

tax-planning techniques—but carried to extremes. That makes it hard to draw sharp lines between

legitimate tax planning and illicit shelters.”

Even when a shelter like those sold by KPMG is found

to be legal, a tax savings is almost always the only outcome. According to an IRS commissioner,“The

only purpose of these abusive deals was to further enrich the already wealthy and to line the pockets

of KPMG partners.”

When a tax shelter is found by the court to be abusive, the usual outcome is simply a loss

of the tax advantage so that the client pays what would be owed otherwise plus any penalties.

The issuer is seldom sanctioned. KPMG and other marketers of tax shelters generally protect

themselves, first, by having the client sign a statement affirming that he or she understands the

structure of the transaction and believes that it serves a legitimate business purpose. This

makes it more difficult for the client to sue the firm. KPMG also sent all related documents to its

lawyers in order to protect them from disclosure by claiming lawyer–client privilege.

Although some partners at KPMG thought that the tax shelters were illegal and raised

objections, others argued for their legality—and, in any event, their shelters were an immensely

profitable part of the firm’s business. Aside from the huge fees, the motivation to market the

shelters came from the KPMG culture, which New York Times business reporter Floyd Norris

characterized as that of a “proud old lion.” He writes, “Of all the major accounting firms, it was

the one with the strongest sense that it alone should determine . . . the rules it would follow.

Proud and confident, it brooked no criticism from regulators.”

Notes

1. Much of the information for this case comes from “Report

of the Honorable John R. Martin, Jr. to the Special

Committee of the Board of Directors of Merck & Co., Inc.

Concerning the Conduct of Senior Management in the

Development and Marketing of Vioxx,” 5 September 2006,

henceforth cited as “Martin Report.”

2. Quoted in John Simons, “Will Merck Survive Vioxx?”

Fortune, 1 November 2004.

3. Anna Wilde Mathews and Barbara Martinez, “E-Mails

Suggest Merck Knew Vioxx’s Dangers at an Early Stage,”

Wall Street Journal, 1 November 2004.

4. Barry Meier and Stephanie Saul, “Marketing of Vioxx:

How Merck Played Game of Catch-Up,” New York Times,

11 February 2005.

5. Alex Berenson, “Evidence in Vioxx Suits Shows

Intervention by Merck Officials,” New York Times,24

April 2005.

6. Mathews and Martinez, “E-Mails Suggest Merck Knew

Vioxx’s Dangers at an Early Stage.”

7. Simons,“Will Merck Survive Vioxx?”

8. Ibid.

9. “Punishment for Merck,” New York Times, 23 August

2005.

10. Martin Report, p. 177.

11. Ibid, p. 179.

12. Richard T. DeGeorge, Competing with Integrity in

International Business (New York: Oxford University Press,

1993), 97–99.

13. This case is adapted from Suzanne Alexander, “Child

World Says Rival Cheats; Toys ‘R’ Us Answers: ‘Grow Up,’

” Wall Street Journal, 19 September 1991, B1.

14. This case is adapted from Steve Lohr, “Lessons from

a Hurricane: It Pays Not to Gouge,” New York Times,

22 September 1992, D1.

15. Albert Z. Carr, “Is Business Bluffing Ethical?” Harvard

Business Review, 46 (January–February 1968), 148.

16. Amartya Sen, “Does Business Ethics Make Economic

Sense?” Business Ethics Quarterly, 3 (1993), 45–54.

17. The results of experiments with the ultimatum bargaining

game are presented in Robert H. Frank, Passions within

Reason: The Strategic Role of the Emotions (New York: W. W.

Norton, 1988), 170–74. For a discussion of the implications

for business ethics, see Norman E. Bowie, “Challenging the

EgoisticParadigm,”Business EthicsQuarterly,1(1991),1–21.

18. Daniel Kahneman, Jack L. Knetch, and Richard Thaler,

“Fairness as a Constraint of Profit-Seeking: Entitlements

in the Market,” American Economic Review, 76 (1986),

728–41.

19. Douglas C. Dacy and Howard Kunreuther, The Economics

of Natural Disasters (New York: Free Press, 1969), 115–16.

Ethics in the World of Business

20. Lynn Sharp Paine, “Law, Ethics, and Managerial

Judgment,” Journal of Legal Studies Education, 12 (1994),

153–69.

21. This phrase is taken from Norman E. Bowie, “Fair

Markets,” Journal of Business Ethics, 7 (1988), 89–98.

22. Christopher D. Stone, Where the Law Ends: The Social

Control of Corporate Behavior (New York: Harper & Row,

1975), 94.

23. See Thomas Donaldson, “Values in Tension: Ethics Away

from Home,” Harvard Business Review,4

(September–October 1996), 48–62.

24. David Luban, Alan Strudler, and David Wasserman,

“Moral Responsibility in the Age of Bureaucracy,”

University of Michigan Law Review, 90 (1991–92), 2366.

25. Robert Jackall, Moral Mazes: The World of Corporate

Managers (New York: Oxford University Press, 1988).

26. For a discussion of these problems, see Joseph L.

Badaracco, Jr., and Allen P. Webb, “Business Ethics: A

View from the Trenches,” California Management Review,

37 (1995), 8–28.

27. Barbara Toffler, Final Accounting: Ambition, Greed, and the

Fall of Arthur Andersen ((New York: Broadway Books,

2004), 257.

28. Saul W. Gellerman, “Why ‘Good’ Managers Make Bad

Ethical Choices,” Harvard Business Review (July–August

1986), 85.

29. For a discussion of the conditions under which this ratio-

nalization might have justificatory force, see Ronald M.

Green, “When Is ‘Everyone’s Doing It’ a Moral

Justification?” Business Ethics Quarterly, 1 (1991), 75–93.

30. Gresham M. Sykes and David Matza, “Techniques of

Neutralization: A Theory of Delinquency,” American

Sociological Review, 22 (1957), 664–70. For an application of

the criminology literature to business ethics, see Joseph

Heath, “Business Ethics and Moral Motivation: A

Criminological Perspective,” Journal of Business Ethics,83

(2008), 595–614.

31. The seminal work in this area was done by Daniel

Kahneman and Adam Tversky, for which Kahneman was

awarded the Nobel Prize in economics in 2002 (Tversky

had died earlier).

32. David M. Messick and Max H. Bazerman, “Ethical

Leadership and the Psychology of Decision Making,”

Sloan Management Review (Winter 1996), 9–22.

33. Max H. Bazerman and Michael D. Watkins, Predictable

Surprises: The Disasters You Should Have Seen Coming,

and How to Prevent Them (Boston, MA: Harvard

Business School Press, 2004).

34. Gino Francesca, Don A. Moore, and Max H. Bazerman, “See

No Evil: Why We Overlook Other People’s Unethical

Behavior,” in Social Decision Making: Social Dilemmas, Social

Values, and Ethical Judgments, ed. Roderick M. Kramer, Ann

E. Tenbrunsel, and Max H. Bazerman (New York: Routledge,

2009) 241–63.

35. These factors are described in John Darley, “How

Organizations Socialize Individuals into Evildoing,” in

Codes of Conduct: Behavioral Research into Business

Ethics, ed. David M. Messick and Ann E. Tenbrunsel

(New York: Russell Sage Foundation, 1996), 13–43.

36. Much of the information for this case is taken from

James Traub, “Into the Mouth of Babes,” New York Times

Magazine, 24 July 1988.

37. The process of developing and marketing tax-shelter

products is described in detail in The Role of Professional

Firms in the U.S. Tax Shelter Industry, Report Prepared by

the Permanent Subcommittee on Investigations of the

Committee on Homeland Security and Governmental

Affairs, United States Senate, 13 April 2005.

38. U.S. Department of Justice, Press Release and Statement

of Facts, 29 August 2005.

39. Cassell Bryan-Low, “KPMG Didn’t Register Strategy:

Former Partner’s Memo Says Fees Reaped from Sales of

Tax Shelter Far Outweigh Potential Penalties,” Wall Street

Journal, 17 November 2003, C1.

40. Ibid.

41. Howard Gleckman, Amy Borrus, and Mike McNamee,

“Inside the KPMG Mess: Why Eight Partners May Be Facing

Jail Time—and What the Justice Dept.’s Suit Could Mean

for the Tax-Shelter Business,” Business Week,5 September

2005, 46–47.

42. Jonathan D. Glater, “8 Former Partners of KPMG Are

Indicted,”

New York Times, 30 August, 2005, C5.

43. Floyd Norris, “KPMG, a Proud Lion, Brought to Heel,”

The New York Times, 30 August 2005, C1.

Ethical Decision Making

CASE 1

HP and the Smart Chip

As a leading innovator in the highly competitive computer printer business, Hewlett-Packard

has promoted its “SureSupply” campaign, which tracks and manages users’ toner and ink levels,

provides alerts when the cartridge needs to be replaced, and directs users to the HP online

store.

HP literature boasts, “With a couple of clicks of a button, customers can access cartridge

information, pricing and purchasing options that best meet their needs from the reseller of

their choice.” The key to SureSupply is a “smart chip,” which is embedded in a cartridge and

communicates with the computer to provide information and send messages and alerts.

Originally used only with more expensive, high-end printers, HP subsequently extended its

smart chip technology across its line of products.

Despite HP’s claim to be providing a “free user-friendly tool,” some customers took a different

view of the smart chip. Users of HP ink-jet printers complained that the smart chip was programmed

to send a premature low-on-ink (LOI) message, while substantial ink remained in the cartridge. They

also contended that the smart chip would render a cartridge inoperable after a predetermined

shutdown date that is not disclosed to users. This date was usually the earlier of 30 months after the

initial installation or 30 months after the “install-by” date. In some instances, a cartridge could shut

down even before it had been installed. Although HP cartridges carry a warranty, the warranty does

not apply, among other conditions, for “products receiving a printer generated expiration message.”

The smart chip also guides users to HP’s own Web store, where they may order a new cartridge. Once

the smart chip had shut down a cartridge, it could not easily be refilled, thus requiring replacement

with a new one. (The European Union has prohibited manufacturers from installing smart chips in

cartridges in an effort to promote recycling. Indeed, the European Parliament uses only recycled

cartridges.) The HP promotional materials, users’ manuals, and packaging reveal little about the

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Ethical Decision Making

features of the smart chip. The box containing a cartridge generally lists the date of the warranty

expiration but not any shutdown date. In an issue unrelated to the smart chip, some users were

disconcerted to learn that certain color ink-jet printers used colored ink when printing in black and

white in a process known as “underprinting” or “under color addition,” which resulted in more rapid

depletion of colored ink. This feature, too, was not commonly disclosed.

When several separate suits were filed between 2005 and 2008 (the courts denied requests

for class-action status), HP vigorously defended its practices, denying that it had done anything

wrong or improper. The company contended that, overall, the smart chip provided a helpful

service to users and ensured a better printing experience. The smart chip was necessary, the

company explained, to enable users to monitor ink levels and be prepared when a replacement

was needed. In any event, the monetary loss to customers was minor compared with the

convenience. The smart chip was also beneficial to HP since replacement cartridges provided

approximately half of the revenues of the Imaging and Printing Group, and “consumables” of all

kinds generated approximately 10 percent of HP’s total revenue. Typically, printers, like razor

holders, are sold at very low cost since the profits lie mainly in the products that go with them.

The profit margin on HP’s ink and toner cartridges ranged between 50 and 60 percent.

Despite the denials of any wrong or improper conduct, HP agreed in 2010 to settle the suits,

which were consolidated into one. In the settlement, HP agreed to state in all on-screen messages,

manuals, and other information that the ink-level information is an estimate only, that actual ink

levels may vary, and that the customers need not replace a cartridge until the print quality is no

longer acceptable. HP also agreed to explain on its website and in manuals the use of expiration

dates and underprinting and also to explain how underprinting may be minimized or eliminated.

Finally, HP agreed to set aside $5 million to provide e-credits to customers who had purchased

certain printers and cartridges. These e-credits, which ranged in amounts from $2 to $6 depending

on the printer in question, could be applied only in the HP online store. The settlement did not

address the use of the smart chip, and it continues to be used by HP and many other manufacturers.

INTRODUCTION

Did HP do anything wrong? The company and its customers have different interests that may

lead them to different answers. Taking the moral point of view requires us to be impartial and to

seek out the best reasons. These reasons may not be easy to identify, however, or to apply. As a

business, HP may rightly seek to develop its products and market them with a view to profits

within certain limits. The smart chip, in the company’s view, serves not only to sell more

cartridges but also to benefit its customers, which is a win-win situation. Customers may com-

plain not only that they pay more than is necessary for products but that they have been misled or

deceived. Yet, how much information is HP obligated to provide? Perhaps we should not consid-

er only a business and its customers since others are affected, as well. A potential business in recy-

cled cartridges is thwarted by the smart chip, and the social problem of waste is exacerbated, as

witness the different response of the European Union. Should these matters also be taken into ac-

count in our ethical reasoning?

In order to identify what makes acts right and wrong and to determine what we ought to do

or what our duties and responsibilities are in particular cases, it is necessary to understand

the elements of ethical decision making. What rules or principles apply to business practice? This

chapter answers this question by dividing business ethics into two parts. The first part considers the

ethics of the marketplace in which two parties, a buyer and a seller, come together to trade or make

an exchange. Although simple in concept, such market transactions are governed by a host of rules

or principles that constitute a market ethics. As prominent as market transactions are to business,

much business activity also involves roles and relationships, such as the role of an employee and the

employer–employee relationship, which are more than mere market transactions. The second part

Ethical Decision Making

of business ethics involves roles and relationships in business, including firms, which are governed

by yet other rules and principles. Finally, this chapter offers a framework for ethical decision making

that consists of seven basic principles that are widely accepted in business practice.

MARKET ETHICS

The ethics of business is, in large part, the ethics of conduct in a market. In a market, individuals

and business firms engage in economic exchanges or transactions in which they relate to each

other mainly or entirely as buyers and sellers. Each market participant offers up something in

trade in return for something that is valued more, and, in theory, each party leaves the market

better off than before, or at least no worse off. Of course, business is more than buyer–seller

exchanges, but a useful place to start an examination of ethical decision making in business is

with an understanding of the ethics of market transactions.

What duties or obligations do market participants have to each other in making trades or

exchanges? Do market actors have any rights that can be violated in market transactions? Are any

market transactions unfair or unjust or otherwise morally objectionable? These questions can be

addressed in the context of simple market exchanges without introducing the complications

that come from considering business as conducted in firms, which is considered following a

discussion of ethics in markets transactions.

The Market System

In a capitalist economy, major decisions about what goods and services to produce, in what vol-

ume to produce them, how to manufacture and market them, and so on are made primarily

through a market. Decisions in a market are made on the basis of prices, which in turn result

largely from supply and demand. The principal aim of business firms in a market system is to

maximize the return on investment or, in other words, to make a profit. Individuals, as well, are

assumed in economic theory to be market actors who trade with each other or else buy products

from or sell their labor or other goods to a firm. Individuals, too, make decisions in a market on

the basis of prices and seek to maximize their own welfare to the limits of their assets. Individuals

make a “profit” for themselves to the extent that what they gain in trade exceeds what they give up.

The market system is characterized by three main features: (1) private ownership of resources

and the goods and services produced in an economy; (2) voluntary exchange, in which individuals

and firms are free to enter into mutually advantageous trades; and (3) the profit motive,whereby

economic actors engage in trading solely to advance their own interests or well-being.

Private ownership in the form of property rights is necessary for a market system because this

is what is transferred in market exchanges. In the sale of a house, for example, the seller, who owns it,

transfers the right to that property to the buyer, who becomes the new owner. A sale differs from theft

or confiscation, moreover, by being voluntary. Whenever a trade takes place voluntarily, we can be

sure that both parties believe themselves to be better off (or, at least, no worse off), because, by

assumption, no one willingly consents to being made worse off. Finally, it is assumed that each

market participant trades solely with a view to his or her own advantage. If two people want the same

thing, then a trade might not be possible. But if each person has what the other wants more, then a

trade is to the advantage of both. Therefore, trading in a market is an instance of mutually advanta-

geous cooperation.

The main justification of a market system over other forms of economic organization is its

promotion of efficiency and hence welfare.

The simplest definition of efficiency is obtaining

the greatest output for the least input. That is, given any volume of our limited resources—

which include raw materials, labor, land, and capital—we want to achieve the greatest volume of

goods and services possible. Efficiency is generally considered to be desirable because these

goods and services increase our overall welfare, and the more of them that we can get, the

greater our level of welfare.

Ethical Decision Making

For example, if Alice sells a book to Bart for $10, she apparently values having $10 more

than the possession of the book, hence her willingness to sell; and similarly Bart would apparently

rather have the book than the $10 he currently possesses, hence his willingness to buy. Before the

transaction, there was an opportunity to increase the overall level of welfare, and the exchange

that takes place turns this opportunity into a reality. Every economic exchange can thus be seen as

a welfare-increasing event, and the more trades that take place, the greater the level of welfare.

Similarly, when firms engage in production, they see an opportunity to purchase inputs, such as

raw materials, machinery, and labor, which can be combined to yield a product that can be sold

to consumers. Like Alice, the sellers of the raw materials, machinery, and labor would rather have

the money they receive for selling their various assets, and, like Bart, the consumers would rather

have the product than the money they give up in payment. In the end, everyone is better off.

What is true of individual market actors, whether people or firms, is also true of an econo-

my as a whole. In an economy built on markets, laborers, in search of the highest possible wages,

put their efforts and skill to the most productive use. Buyers seeking to purchase needed goods

and services at the lowest possible price force sellers to compete with one another by making the

most efficient use of the available resources and keeping prices at the lowest possible level. The

resulting benefit to society as a whole is due not to any concern with the well-being of others, but

solely to the pursuit of self-interest. By seeking only personal gain, each individual is, according to

a famous passage in Adam Smith’s The Wealth of Nations,“led by an invisible hand to promote an

end which was no part of his intention.” Smith continued, “Nor is it always the worse for the

society that it was no part of it. By pursuing his own interest he frequently promotes that of the

society more effectually than when he really intends to promote it.”

In addition to welfare enhancement, the market system is morally desirable because it

promotes freedom or liberty. The opportunity to make trades is an exercise of liberty by which

individuals are able to advance their interests in society, thus promoting democracy. A market is an

instance of what Friedrich von Hayek calls a spontaneous order, which contrasts with the planned

order of a state-owned, socialist economy, in which a central authority sets goals and organizes peo-

ple’s activities to achieve them.

In a spontaneous order, the only goals are those that individuals set

for themselves, and the only coordination is that provided by the rules for people’s interaction, which

permit them to enlist the cooperation of others, each in the pursuit of his or her own goals. The

advantages of spontaneous order are, first, that it protects and expands the basic rights to liberty and

property. Second, a spontaneous order will generate a much greater complexity than could be

produced by deliberate design. A planned order is limited by the vision and skill of a few people, but

a spontaneous order allows everyone to participate in an economy and make a contribution.

A stronger argument for the market system and perhaps the decisive reason for the failure of

socialism is the ability of markets to utilize information. A central planner faces the formidable task of

gathering all available information about such matters as people’s preferences for products, the supply

of raw materials, the capacity and condition of machines and workers, the state of distribution facili-

ties, and many other factors. Not only is the amount of information required for economic decision

making immense, but also the details are constantly changing. Put simply, the information-gathering

and processing requirements of central planning outstrip the capabilities of any one person or group

of people. Markets solve this problem by enabling individuals to utilize the information that they pos-

sess in ways that can be known by others. This is done mainly through the price system. The prices of

all manner of goods and services reflect the available information, and these prices may fluctuate as

new information becomes available. Thus, the market system may be justified on the multiple

grounds of enhancing welfare, securing rights and liberty, and utilizing all available information.

Ethics in Markets

If a market transaction is wholly voluntary, then how can one market actor wrong another? In a

free market, every participant seeks his or her own benefit and has no obligation to protect or pro-

mote or otherwise consider the interest of the other party. Exclusive self-interest is an accepted and

Ethical Decision Making

justified motive for trading. However, in a market people are able to get what they want only with

the cooperation and voluntary consent of others; acquisition without consent is a kind of theft.

Consequently, everyone’s gains in a market are by mutual agreement or consent, in which case no

moral wrongs are possible. Indeed, the philosopher David Gauthier has characterized perfectly

competitive markets as morally free zones, where there is no place for moral evaluation.

A world

where all activity took place in a perfectly competitive market would have no need of morality.

The idea that a market is a morally free zone such that no wrong can occur from each

participant pursuing his or her own advantage with the voluntary consent of others presupposes,

as Gauthier makes explicit, the ideal of a perfectly competitive, properly functioning market. In

such a market, it is assumed, first, that everyone completes an exchange by fulfilling the terms of

all agreements. Every market transaction can be viewed as a kind of contract, and so one moral

requirement of a market system is that each participant observe all contracts made. In law, a

failure to do this would be called a breach of contract, which is a legal and moral wrong.

Second, a voluntary exchange precludes force or fraud. Any transfer by force is not a

market transaction but an instance of theft or expropriation, which is an obvious legal and

moral wrong. By contrast, fraud is a more subtle wrong that is not an uncommon occurrence

in market transactions and that, like force, is also prohibited by law. Indeed, fraud, which is

discussed in the next section, is a major concern in business ethics.

Third, market transactions can result in harm to persons that constitute a wrongful harm when

the harm results from some wrongful act. For example, the harm done to the buyer of a defective

product is a wrongful harm if the seller has a duty to ensure the safety of the product when properly

used. Similarly, an employer has a duty not to discriminate, and so the refusal to hire or promote a

person on the basis of race or sex is also an instance of a wrongful harm. Such wrongful harms are the

subject of the law of torts, which is often the basis of suits for injury or loss of some kind.

Fourth, perfect markets require a number of conditions, and when these fail to obtain, the

personal and social benefits that result from mutually advantageous cooperation, as described in

Adam Smith’s invisible hand argument, may not occur. The absence of these conditions leads to a

number of commonly recognized situations known as market failures, which are discussed later

in this chapter.

Consequently, wrongs can occur in actual, as opposed to ideal or perfect markets, and

market ethics may be characterized as the ethical rules that apply in imperfect market exchanges

or transactions to address recognized market failures. Because market failures are also addressed

by much government regulation, there is an extensive overlap between business ethics and the

moral rationale or justification for this regulation. Market ethics, which is to say the ethics that

applies when the conditions for perfect markets do not obtain, can be categorized under the four

headings of (1) observing agreements or contracts, (2) avoiding force and fraud, (3) not inflicting

wrongful harms, and (4) acting responsibly in cases of market failures. Since much of business

ethics consists of this market ethics, a further examination of the four headings follows.

Breaches and Fraud

Breach of contract and fraud, which are two wrongs that can occur in market transactions, are

not only major concerns of law but also of common morality. Indeed, they are violations of two

basic moral values: promise keeping and honesty. Every market trade or exchange is a kind

of promise, and so a failure to honor what is agreed to in a transaction is the breaking of a

promise. And inasmuch as fraud necessarily involves a knowing or intentional falsehood, it is a

form of dishonesty. Much of business ethics can be reduced to two rules: keep your promises and

be honest!

BREACHES OF CONTRACT. A market actor who fails to perform—by not delivering

promised goods or refusing to pay, for example—is obviously breaching an agreement or con-

tract, and such cases of nonperformance are obviously wrong and require little explanation.

However, actual contracts are often vague, ambiguous, incomplete, or otherwise problematic

Ethical Decision Making

so that reasonable people may be uncertain or disagree about whether a contract’s terms have

been fulfilled. Disputes of this kind, which are not uncommon, are often taken to court. In

actual business practice, three main ethical problems with contracts arise.

First, many contracts in business are not explicitly formulated but are left implicit because of a

desire or a need to avoid excessive legalism and to keep some flexibility. Business is sometimes better

conducted with a handshake than a written contract. Thus, employee contracts may contain explicit

terms about pay and job description, but leave implicit any promises of specific job responsibilities,

advancement opportunities, or guarantees of job security. Such matters may be better left to the

unstated understandings of implicit contracts rather than to the legally enforceable language of

explicit contracts. However, implicit contracts are subject to disagreements, and since they are gener-

ally not legally enforceable, they may be violated with impunity. For example, a laid-off employee

may believe that he had been guaranteed greater job security than was the case, or a company may

change its policy to offer less job security, which may be legally permissible in the absence of an

explicit contract.

Second, a perfect contract in which every detail and contingency are addressed may be impos-

sible to formulate because the transaction is too complex and uncertain to plan fully. Even if a fully

explicit contract is sought, it may be impossible to draft it in complete detail. For example, in hiring a

chief executive officer (CEO), neither the CEO nor the board of a company can anticipate all the

situations that might arise and agree upon detailed instructions for acting in each one. Indeed, the

CEO is being hired precisely for an ability to manage complexity and to handle unanticipated events

successfully. The best that can be done is typically to require the CEO to exert his or her best effort, to

set and reward certain goals, and to impose a fiduciary duty to act in the shareholders’ interest. The

CEO’s contract with a firm is necessarily an incomplete contract.

Third, the contracts that occur in market exchanges often consider only the duties or oblig-

ations of each party to the other and fail to specify the remedies in cases of breach. What ought to

be done in cases where one party is unable or unwilling to fulfill a contract? Such situations are

often the subject of ethical and legal disputes. While remedies for breaches can usually be made

explicit, there is evidence that firms often prefer to leave this matter implicit, in which case courts

are called upon to determine a just outcome.

One problematic area of justice in breaches occurs

when a party does not observe a contract in which the cost of observance would exceed the

penalty for breach. A question of ethics arises, for example, when homeowners who owe more on

a mortgage than a house is worth walk away and return the house to the bank. On the one hand,

the homeowner has signed a loan agreement to repay the full amount of the loan, and, on the

other, the contract signed provides only for repossession as the penalty for nonpayment.

These three features of contracts—being implicit and incomplete and lacking remedies—

give rise to many situations in which the ethical course of action is unclear and disputable.

One possible guide in such cases is to try to determine what more explicit and complete contracts

the parties might have agreed to before the situation arose. To use this guide is to ask what is the

fairest resolution for both parties.

FRAUD. Fraud is one of the most common violations of business ethics, and the many fraud

statutes on the books provide a powerful arsenal of legal tools to prosecute people for a wide

variety of misdeeds. Consequently, it is essential for business people to understand what actions

constitute fraud. A few incautious remarks have led to costly legal judgments and fines and even

to years of imprisonment for not a few executives, and some companies have been seriously

damaged and even bankrupted by fraudulent schemes.

Fraud is commonly defined as a material misrepresentation that is made with an intent to

deceive and that causes harm to a party who reasonably relies on it. This definition contains five ele-

ments: (1) the making of a false statement or the misrepresentation of some fact; (2) materiality,

which means that the fact in question has some important bearing on the business decision at hand;

(3) an intent to deceive, which is a state of mind in which the speaker knows that the statement is false

and desires that the hearer believe it and act accordingly; (4) reliance, by which the hearer believes the

Ethical Decision Making

statement and relies on it in making a decision; and (5) harm, which is to say that the decision made

by the hearer on the basis of the misrepresentation leads to some loss for that person. The first three

conditions bear on whether the speaker has acted wrongly, while the last two are relevant to whether

the hearer has been wronged and deserves some compensation.

The simplicity of this definition is deceptive because each of the five elements hides a host of

subtle pitfalls for the unwary. For starters, a misrepresentation need not be spoken or written but

may be implied by word or deed, as when, for example, a used car dealer resets an odometer, which

is a clear case of consumer fraud. Partial statements and omissions may constitute fraud when they

are misleading within the context provided. Thus, the used car dealer who fails to disclose certain

faults or presents them in a way that minimizes their seriousness may be guilty of fraud. Saying

nothing, which avoids the risk that a partial statement is misleading, may still constitute fraud if

one has a duty to disclose. Such a duty may be the result of one’s position or the nature of the facts.

Thus, a real estate agent has a duty, as an agent, to inform a buyer of certain facts about a home

sale, and the seller generally has a duty to disclose certain hidden faults, such as termite damage.

Generally, opinions, predictions, and negotiating positions do not constitute facts that

can be misrepresented. It is not usually considered material in negotiation to conceal or even

lie about the amount one is willing to accept or pay, which is known as one’s reservation price.

Certain amounts of bluffing and exaggeration in negotiation are usually permissible, also on

the grounds that the harm is not material. However, one’s intentions—such as making a

promise that might not be kept—are commonly regarded as facts about a speaker’s state of

mind so that the misrepresentation of such matters may constitute fraud.

Although intent, being a mental state, is difficult to ascertain, the fact that a person knows

the true state of affairs is usually sufficient to establish it. More difficult are cases of willful

ignorance, where a seller of a house, for example, declines to engage a termite inspector to check

suspicious deposits of sawdust in the basement, so he can truthfully tell a buyer, “I don’t know,”

when asked about any termites. Finally, it is often difficult to know whether a party to a transac-

tion actually relied on a misrepresentation in making a decision or did so reasonably. Thus, a

seller’s deceptive claim to be ignorant of termite damage may have played no role in the buyer’s

decision. And even if it did, should the buyer have engaged his or her own termite inspector

instead of relying (perhaps unreasonably) on the seller’s vague denial? Generally, in negotiation,

it is unwise to act solely on the other party’s words, and market participants have some obligation

to determine the facts themselves.

Wrongful Harms

Although buyers and sellers in market exchanges have no duty to consider the other party’s

interest, they still have the obligations of basic morality toward each other and deserve compen-

sation when they suffer some loss when the other party acts in violation of some obligation. For

example, a manufacturer has an obligation beyond any warranty extended (which is a kind

of contract) to exercise due care and avoid negligence in producing goods, so that a buyer of

the product who is injured has some claim for compensation. In law, this claim is based not on

contract law but on tort law, which is the law of wrongful harms. Although wrongful harms can

occur in the course of a market transaction—buying the product, in this case—they occur in

many instances that do not involve markets at all. Thus, a company might be sued for a defective

product not only by the injured buyer but also by anyone who suffers an injury from a defective

product. The ethics involved in wrongful harms overlaps with but is much more extensive than

merely market ethics.

Market participants give their voluntary consent to a transaction, and in general, consent is

an excusing condition when harm is inflicted. That is, the buyer of a stock that declines in value

may lose in a transaction, but he or she believed at the time of the purchase that the stock was a

good value and was aware of the possibility of loss. Such a person has only himself or herself to

blame for the loss. The seller can say, “I am not to blame; it’s your own fault.” On the other hand,

Ethical Decision Making

the buyer of a defective product consents to the purchase but not to the possibility of injury.

Similarly, the victims of a stock fraud, such as the Ponzi scheme perpetrated by Bernard Madoff,

cannot be said to have consented to their losses. The ethical transgressions in both cases do not lie

in the market transactions themselves but in the wrongs that accompany them, namely, the

negligence of the manufacturer and the fraud of Mr. Madoff.

The wrongs in wrongful harms are many and varied and constitute much of business ethics

and the whole of tort law. On the side of the violators, these wrongs involve a failure to fulfill a

duty, often the duty of due care, or involve its opposite, the commission of negligence. That is, man-

ufacturers have a duty to exercise due care and not be negligent in the products they market to

consumers, in the working conditions they provide for employees, in their environmental impacts

they have on communities, and so on. Generally, due care and negligence apply to unintentional

harms, but companies also have a duty to avoid intentional harms that result not from negligence

but from deliberate or purposeful actions. On the side of victims, wrongful harms typically

involve a violation of rights. Thus, consumers have a right to safe products; employees have a right

to a safe and healthy workplace; everyone has privacy rights, property rights, a right not to be dis-

criminated against, and so on. The violations of these rights—whether they are due to negligence

or intentional actions, or are committed in markets transactions or not—are wrongful harms.

Market Failures

The virtues of the market system, including its efficiency and Adam Smith’s “invisible hand”

argument, occur only under certain ideal conditions and not necessarily in the real world where

we live. Some departures from these ideal conditions are serious enough to be described by

economists as market failures. Indeed, much of business ethics involves questions about how to

respond to such failures.

CAUSES OF MARKET FAILURES. Markets fail for four main kinds of reasons, which may be

grouped under the headings of perfect competition, perfect rationality, externalities, and collec-

tive choice.

First, the argument that free markets are efficient presupposes perfect competition. This

condition is satisfied when there are many buyers and sellers who are free to enter or leave the

market at will and a large supply of relatively homogeneous products that buyers will readily

substitute one for another. In addition, each buyer and seller must have full knowledge of the

goods and services available, including prices. In a market with these features, no firm is able to

charge more than its competitors, because customers will purchase the competitors’ products

instead. Also, in the long run, the profit in one industry can be no higher than that in any other,

because newcomers will enter the field and offer products at lower prices until the rate of profit is

reduced to a common level.

Competition in actual markets is always imperfect to some degree. One reason is the exis-

tence of monopolies and oligopolies, in which one or a few firms dominate a market and exert an

undue influence on prices. Competition is also reduced when there are barriers to market entry

(as in pharmaceuticals that require costly research), when products are strongly differentiated

(think of the iPhone, which many people strongly prefer despite similar alternatives), when some

firms have information that others lack (about new manufacturing processes, for example), and

when consumers lack important information. Competition is also reduced by transaction costs,

that is, the expense required for buyers and sellers to find each other and come to an agreement.

Second, the argument that free markets are efficient makes certain assumptions about

human behavior. It assumes, in particular, that the individuals who engage in economic activity

are fully rational and act to maximize their own utility.

This construct, commonly called Homo

economicus or economic man, is faulty for at least two reasons. One is that people often lack the

ability to gather and process the necessary information to act effectively in their own interests.

Economic actors have what is described as bounded rationality. The other reason is that human

motivation is much more complex than the simple view of economic theory. People often give