Chapter 3 Discussion Questions
1. In her book ‘Seven Signs of Ethical Collapse,’ Jennings explains: “When an
organization collapses ethically, it means that those in the organization have drifted into
rationalizations and legalisms, and all for the purpose of getting the results they want
and need at almost any cost.” Discuss what you think Jennings meant by this statement.
Jennings discusses that it’s not “the first mistake that an organization makes that brings it down.
It’s the second mistake, the cover-up, and everything that follows that creates the ethical
collapse.” She notes that an ethical culture alone will not prevent an ethical lapse. That’s because
humans run the organizations. As long as there are humans there will be mistakes and ethical
lapses. How those mistakes and ethical lapses are reported, to whom they are reported, and how
those mistakes and ethical lapses are then treated determine whether it leads to ethical collapse.
Pressure makes good people do ethically dumb things. Pressures could be meeting aggressive
2. Five months before the new 2002 Lexus ES hit showroom floors, the company’s U.S.
engineers sent a test report to Toyota City in Japan: The luxury sedan shifted gears so
roughly that it was “not acceptable for production.” The warning was sent to Toyota
Executive Vice President Katsuaki Watanabe on May 16, 2001. Days later, another
Japanese executive sent an e-mail to top managers saying that despite misgivings
among U.S. officials, the 2002 Lexus was “marginally acceptable for production.” The
new ES went on sale across the nation on Oct. 1, 2001.
In years to come, thousands of Lexus buyers would discover firsthand that the vehicle’s
transmission problems, which caused it to hesitate when motorists hit the gas, or lurch
forward unintentionally, were far from fixed. The 2002-2006 ES models would become
the target of lawsuits, federal safety investigations and hundreds of consumer
complaints, including claims of 49 injuries.
In an August 15, 2005, memo explaining the company’s position, a staff attorney wrote:
“The objective will be to limit the number of vehicles to be serviced to those owners
who complain and to limit the per-vehicle cost.”
In 2010, Toyota was fined a record $16.4 million for delays in notifying federal safety
officials about defects that could lead to sudden acceleration. The reaction of a Toyota
spokesperson was: “Given the concerns raised by some customers about this drivability
issue, we did not meet the very high customer satisfaction standards we set for
ourselves. However, we fully stand behind the engineering and production quality of the
vehicle, as well as our after-sale customer service and technical support.“
Evaluate Toyota’s actions from a corporate governance perspective. How would you
characterize the ethical culture at Toyota at least with respect to the Lexus incident?
Can you draw any parallels between the Toyota experience and how Ford handled the
matter with the Pinto?
A review of the Ford Pinto situation: The Ford Pinto experienced fires in low-impact rear-end
collisions because, in part, the gas tanks were directly behind the license plate. Ford did a risk-
benefit analysis to aid decision making. Ford relied on ethical legalism to justify and rationalize
The Lexus situation parallels the Ford Pinto. Toyota and the Lexus brands have had acceleration
problems and complaints for over 25 years, since 1993. Lexus first blamed the problems on the
During the three decades of 1960 – 1990, Japan became the third largest auto manufacturing
country and the largest electronics goods industry. In 1992, the Japanese stock market
Japanese companies tend to include all stakeholders in the corporate governance process,
particularly workers; to have larger board of directors; to be more concerned about workers’
salaries, working conditions, and lifelong employment rather than maximizing shareholder’s
wealth; and to have less incentive pay for workers. The Japanese business culture reflects
The Lexus acceleration problem seems to show moral blindness and group think on the part of
the firm. The firm may have felt pressure to maintain leadership and quality in the auto market. It
is interesting to note that in the U.S. such moral blindness tend to be with management and often
3. The following questions deal with issues related to executive compensation:
(a) What is the business judgment rule and how does it relate to executive
compensation?
A corporate director or officer may be able to avoid liability to the corporation or to its
shareholders for poor business judgment as long as he/she exercised due care and used one’s best
judgment in guiding decision-making. The corporate director or officer is not an insurer of
(b) On August 9, 2005, Chancellor William B. Chandler III of the Delaware
Chancery Court1 ruled that the directors of the Walt Disney Company acted in
good faith when Michael Ovitz was hired in 1995 to be the CEO of Disney and
then allowed to walk away 15 months later after being fired by Michael Eisner,
the chair of the Disney’s board of directors, with a severance package valued at
$130 million. Is it “fair” that Ovitz was allowed to walk away with such a
lucrative severance package only 15 months after being fired? Include in your
discussion what is fairness in this instance from an ethical perspective.
Owners expect the board to choose, evaluate, and compensate top executives. The board’s duty is
1 The Delaware Court of Chancery is widely recognized as the preeminent forum in the
United States for the determination of disputes involving the internal aairs of thousands of
Delaware corporations and other business entities, especially matters of board of director
responsibilities. The court has jurisdiction to hear all matters related to equity. Its decisions
can be appealed to the Delaware Supreme Court.
Did the board, and the board chair, especially, give a fair effort to finding a CEO to manage the
company? Did the candidate (Ovitz) accept the job with the intention of doing his best at the job
or did he accept the job with the intention to be fired and thereby receive the golden parachute?
4. Explain the “say on pay rule” and whether you believe it is likely to have an effect
on large compensation packages of CEOs.
.The Dodd Frank Act includes “say-on–pay” provisions (Section 951) that require SEC-
registered issuers to provide shareholders at least once every three calendar years with a
separate nonbinding say-on-pay vote regarding the compensation of the company’s named
executive officers (i.e., CEO and CFO), and the company’s three other most highly
compensated officers. Although the vote on compensation is nonbinding, the company must
The chapter details Citigroup’s shareholders voting against CEO Vikram Pandit’s $15 million
compensation package for 2011, a year when the bank’s stock tumbled. At the time of the vote,
Pandit had received nearly $7 million in cash for 2011, with the remainder to be paid in restricted
5. Distinguish between agency theory, stakeholder theory, and stewardship theory with
respect to controlling the actions of managers.
Agency theory concerns the difficulties in motivating management (i.e., the agent) to act in the
best interests of the shareholders (i.e., principal). Agency theory tries to solve this problem by
In the traditional view of the firm or the shareholder view, the shareholders or stockholders are
the owners of the company, and the firm has a binding fiduciary duty to put their needs first, to
increase value for them. However, stakeholder theory argues that there are other parties
involved, including governmental bodies, political groups, trade associations, trade unions,
Stewardship theory is a theory that managers, left on their own, will indeed act as responsible
6. Do you believe a member of the audit engagement team servicing a client should
also serve on the audit committee of the board of directors of the client entity? Why
or why not?
Auditor independence rules do not allow the auditor to act as member of a clients’ management
team, board of directors, or audit committee. Particularly on the audit committee a member of the
audit engagement team would have a conflict of interest and loss of independence. Auditors must
7. COSO explains the importance of the control environment to internal controls by
stating it sets the tone of an organization, influencing the control consciousness of its
people. It is the foundation for all aspects of internal control, providing discipline
and structure. Explain what is meant by this statement.
The control environment includes the company’s history, values, tone at the top, organizational
structure, operating style, board of directors, audit committee, management attitude towards risk,
management commitment to quality, use of authority and responsibility within the company,
The control environment provides the structure and discipline for the internal control function. It
influences the design and functioning of all control activities and control consciousness of
employees. It influences how goals, objectives and strategies are established. The attitudes,