CHAPTER 4
The Institutionalization of Business Ethics
SUMMARY
In this chapter, we examine the boundaries of ethical conduct and focus on the voluntary, core practices, and
mandated requirements for legal compliance—three important areas in developing an ethical culture. In
particular, we concentrate on compliance in specific areas related to competition, consumers, and safety. We
consider the requirements of the Sarbanes–Oxley legislation, its implementation by the Securities and
Exchange Commission (SEC), and how its implementation has affected companies. We also examine the
Dodd-Frank legislation and its rules affecting the finance industry. Additionally, we provide an overview of
the FSGO for organizations and give recommendations and incentives for developing an ethical corporate
culture. The FSGO, the Sarbanes–Oxley Act, the Dodd-Frank Act, industry trade associations, and societal
expectations support core practices. Finally, we examine voluntary responsibilities and look at how
cause-related marketing and strategic business philanthropy can be important tools in managing stakeholder
relationships., cause-related marketing, and social entrepreneurship, along with how strategic philanthropy
can be an important core competency to manage stakeholder relationships.
INSTRUCTOR NOTES FOR “AN ETHICAL DILEMMA”
Students may wish to discuss the dilemma in which a supervisor tells Randy, a newly hired employee, to
extend the expiration dates on some medications, contradicting his training and his better judgment. Randy
works for Meeker, a medical warehouse supplying medication and equipment to hospitals. Meeker trained
Randy for the first two months of his employment, schooling him in hospital and clinic regulations, laws,
various system procedures, and software applications.
Meeker supplies hospitals in three states. When these hospitals conduct their annual inventory, the warehouse
replaces any expired medication with new products. Cheryl, Randy’s supervisor, assigns him the task of
traveling to an area hospital and inspecting their expired inventory. However, instead of replacing the expired
over–the-counter medications, Cheryl tells him to replace only the labels. Cheryl provides Randy with labels
featuring extended expiration dates.
Cheryl says the company uses shorter expiration dates than their competitors, putting them at a disadvantage.
She identifies the idea of replacement labels as her own idea, and when Randy questions the safety of the
product, Cheryl assures him their competitors offer longer expiration dates and cause no harm.
Randy’s dilemma is whether to follow Cheryl’s instructions or not. He can remember personally taking
expired over-the-counter medications in the past with no ill effects, and the new labels only extended the time
by three months. However, his feeling of unease grew because this went against his training, which cautioned
against using expired medication. How was he to explain the lack of credit on the account when he asked
someone to sign off on the paperwork when he left? How would he explain the “new policy” to them without
being dishonest?
21 Chapter 4: The Institutionalization of Business Ethics
What kind of responsibility does Randy have to the different stakeholders involved in this situation? Does his
responsibility to Meeker differ from his responsibility to the hospitals?
Since Cheryl identified this as her own idea, should Randy take this to another supervisor? Would that make
him a tattletale, or a whistleblower? Randy’s training included various system procedures. Does this idea
sound like standard operating procedure?
LECTURE OUTLINE
I. Managing Ethical Risk Through Mandated and Voluntary Programs
A. Voluntary practices include beliefs, values, and voluntary contractual obligations. All businesses
engage in some level of commitment to voluntary activities in order to benefit both internal and
external stakeholders.
B. Most firms engage in strategic philanthropy—giving back to communities and causes.
C. Core practices are documented best practices, often encouraged by legal and regulatory forces as
well as trade associations.
1. The Better Business Bureau (BBB) is a leading self-regulatory body that provides directions
for managing customer disputes and reviews advertising cases.
2. Core practices are appropriate and common practices that have industry acceptance and meet
societal expectations.
D. Mandated boundaries are the externally imposed levels of appropriate conduct, such as laws,
rules, and regulations. imposed boundaries of conduct, such as laws, rules, regulations, and other
requirements.
1. Corporate governance, compliance, risk management, and voluntary activities all help to
maintain an ethical culture and to manage stakeholder expectations for appropriate conduct in
an organization.
2. Compliance represents areas that must conform to existing legal and regulatory requirements.
3. Corporate governance is structured by a governing authority providing oversight and checks
and balances to make sure that the organization meets its goals and objectives for ethical
performance.
4. Risk management analyzes the probability or chance that misconduct could occur based on the
nature of the business and the exposure to risky events.
5. Voluntary activities often represent the values and responsibilities that firms accept in
contributing to stakeholder needs and expectations.
E. An ethical culture consists of values, norms, artifacts, and behavior.
1. Norms dictate and clarify desirable behaviors through principles, rules, policies, and
procedures.
2. Artifacts are visible, tangible external symbols of values and norms (e.g., rituals, codes of
ethics).
II. Mandated Requirements for Legal Compliance
A. Laws and regulations are established by governments to set minimum standards for responsible
behavior—society’s codification of what is right and wrong.
Chapter 4: The Institutionalization of Business Ethics 22
B. Laws regulating business conduct are passed because certain stakeholders believe that business
cannot be trusted to do what is right in certain areas, such as consumer safety and environmental
protection.
1. Civil law defines the rights and duties of individuals and organizations (including businesses).
2. Criminal law prohibits specific actions—such as fraud, theft, or securities trading violations—
and imposes fines or imprisonment as punishment for breaking the law.
3. The state or nation enforces criminal laws, while individuals enforce civil laws.
a. Criminal and civil laws are derived from four sources: the U.S. Constitution (constitutional
law), precedents established by judges (common law), federal and state laws or statutes
(statutory law), and federal and state administrative agencies (administrative law).
b. The Consumer Financial Protection Agency was established through the Dodd-Frank Act
after the latest financial crisis, which resulted in many consumers losing their homes.
c. The primary method of resolving conflicts and serious business ethics disputes is through
civil lawsuits in which one individual or organization uses civil laws to take another
individual or organization to court. Lawsuits are expensive and many organizations seek to
avoid them.
d. Laws establish the basic ground rules for responsible business activities.
C. Laws Regulating Competition
1. The issues surrounding the impact of competition on a business’s social responsibility arise
from the rivalry among businesses for customers and profits.
a. The primary objective of U.S. antitrust laws is to distinguish competitive strategies that
enhance customer welfare from those that reduce it.
b. Intense competition leads some companies to resort to corporate espionage.
2. Procompetitive legislation involves laws that have been passed to prevent the establishment of
monopolies, inequitable pricing practices, and other practices that reduce or restrict competition
among businesses.
a. They were enacted to encourage competition and prevent activities that restrain trade.
b. There are some exceptions. Under the McCarran-Ferguson Act of 1944, Congress
exempted the insurance industry from the Sherman Antitrust Act and other antitrust laws.
i) However, even actions that take place under this legal “permission” could still be
viewed irresponsible and unethical if it neutralizes competition and if prices no longer
reflect the true costs of insurance protection.
D. Laws Protecting Consumers
1. Laws that protect consumers require businesses to provide accurate information about products
and services and to follow safety standards. The first consumer protection law was passed in
1906.
a. Upton Sinclair’s The Jungle and Ralph Nader’s Unsafe at Any Speed had tremendous
impacts on consumer protection laws.
2. Large groups of people with specific vulnerabilities have been granted special protections under
the law (the elderly, children, etc.)
a. The Children’s Online Privacy Protection Act (COPPA) requires Internet sites to carry
privacy statements, obtain parental consent before soliciting information from children
under the age of 13, and provide an opportunity to remove any information provided by
children using these sites.
3. The FTC’s Bureau of Consumer Protection was created to protect consumers against unfair,
deceptive, or fraudulent practices. It is divided into five divisions.
23 Chapter 4: The Institutionalization of Business Ethics
4. The Food and Drug Administration regulates food safety, human drugs, tobacco, dietary
supplements, vaccines, veterinary drugs, medical devices, cosmetics, products that give off
radiation, and biological products.
E. Laws Promoting Equity and Safety
1. Laws promoting equity in the workplace were passed during the 1960s and 1970s to protect the
rights of minorities, women, older persons, and persons with disabilities; other legislation has
sought to protect the safety of all workers.
a. Of these laws, probably the most important to business is Title VII of the Civil Rights Act,
originally passed in 1964 and amended several times since.
i) Title VII specifically prohibits discrimination in employment on the basis of race, sex,
religion, color, or national origin.
ii) The Civil Rights Act also created the Equal Employment Opportunity Commission
(EEOC).
b. The Occupational Safety and Health Administration (OSHA) makes regular inspections
to ensure that employees have a safe working environment.
c. Many employees still work in unhealthy or dangerous environments, in spite of the passage
of laws to protect them.
d. Competitive pressures can lead to workplace safety problems, such as manufacturing
injuries or careless accidents by overworked employees.
III. The Sarbanes–Oxley (SOX) Act
A. Congress passed the Sarbanes–Oxley Act in 2002 to establish a system of federal oversight of
corporate accounting practices.
1. The law requires corporations to establish codes of ethics for financial reporting and to develop
greater transparency in financial reporting to investors and other stakeholders.
2. The Public Company Accounting Oversight Board represents the heart of Sarbanes-Oxley.
a. It oversees the audit of public companies in order to protect the interests of investors and to
further the public interest in the preparation of informative, accurate, and independent audit
reports for companies.
b. The Sarbanes–Oxley Act also seeks to ensure auditor and analyst independence, in order to
reduce conflicts of interest and to ensure enhanced financial disclosures of public
companies’ true condition. Registered public accounting firms can no longer provide both
auditing and non-auditing services to public companies.
i) It also raised a number of concerns. For instance, it imposed additional requirements
and costs on companies, caused many firms to restate their earnings to avoid penalties,
and still had loopholes executives could exploit that allowed firms to engage in
misconduct.
c. The Sarbanes–Oxley Act is better able to ensure compliance with the enhanced financial
disclosures of public companies’ true condition
d. Sarbanes–Oxley offers whistle-blower protection to employees that would prohibit the
employer from taking certain actions against employees who lawfully disclose private
employer information. However, employees who witness wrongdoing are often still afraid
to be whistle-blowers because of backlash and difficulties finding employment elsewhere.
Chapter 4: The Institutionalization of Business Ethics 24
e. The national cost of compliance to the Sarbanes–Oxley Act was high, but studies show that
the costs of compliance have gone down somewhat since the law’s implementation.
IV. Dodd-Frank Wall Street Reform and Consumer Protection Act
A. The Dodd-Frank Act was passed to improve financial regulation, increase oversight of the industry,
and prevent the type of risk-taking, deceptive practices, and lack of oversight that led to the
2008-2009 financial crisis.
B. One of the provisions of the Dodd-Frank Act instituted the creation of two new financial agencies.
1. The Office of Financial Research is charged with improving the quality of financial data
available to government officials and creating a better system of analysis for the financial
industry.
2. The Financial Stability Oversight Council (FSOC) is responsible for maintaining the stability of
the financial system in the United States through monitoring the market, identifying threats,
promoting market discipline among the public, and responding to major risks that threaten
stability.
C. The Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) to regulate
consumer financial products and protect consumers from deceptive or toxic financial instruments.
1. The CFPB has the responsibility to curtail unfair lending and credit card practices, enforce
consumer financial laws, and check the safety of financial products before their launch into the
market.
2. Critics believe that the CFPB has too much power that could result in heavy sanctions for
financial institutions.
D. The Dodd-Frank Act instituted a whistle-blower bounty program to reward whistle-blowers who
report misconduct to the SEC.
1. Whistle-blowers who report financial fraud to the Securities and Exchange Commission and
Commodities Exchange Commission are eligible to receive 10 percent to 30 percent of fines
and settlements if their report results in a conviction of more than $1 million in penalties.
V. Laws That Encourage Ethical Conduct
A. Laws and regulations have been passed to discourage unethical decisions—and to foster programs
designed to improve business ethics and social responsibility.
B. The most important of these are the FSGO, the Sarbanes–Oxley Act, and the Dodd-Frank Act.
C. The development of reporting systems has advanced.
VI. Federal Sentencing Guidelines for Organizations
A. The FSGO was passed in 1991 to create an incentive for organizations to develop and implement
programs designed to foster ethical and legal compliance.
1. It applies to all felonies and class A misdemeanors committed by employees in association with
their work.
2. The commission delineated seven steps companies must implement to demonstrate due
diligence.
a. A firm must develop and disseminate a code of conduct that communicates required
standards and identifies key risk areas for the organization.
b. High-ranking personnel known to abide by legal and ethical standards of the industry
should be in charge of the program.
25 Chapter 4: The Institutionalization of Business Ethics
c. No one with a known propensity for misconduct should be put in a position of authority.
d. A communications system for disseminating standards and procedures must be put in place.
e. Organizational communications should include a way for employees to report misconduct
without fearing retaliation.
f. If misconduct is detected, the firm must take appropriate and fair disciplinary action.
g. After misconduct has been discovered, the organization must take steps to prevent similar
misconduct in the future.
B. A 2004 amendment to the FSGO requires that a business’s governing authority be informed about
its ethics program with respect to content, implementation, and effectiveness.
C. A 2005 Supreme Court decision held that the federal sentencing guidelines were not mandatory but
should serve only as recommendations for judges to use in their decisions.
D. 2007–2008 amendments to the FSGO extend the ethics training of individuals to members of the
board or governing authority, high-level personnel, employees, and the organizations’ agents.
E. The Guidelines had four new amendments in 2010. The guidelines recommended:
1. simplifying the complexity of reporting relationships
2. encouraging companies to extend their internal ethical controls
3. adding more specific language of the word “prompt” to help employees recognize what it
means to report an ethical violation promptly
4. amending the extent of operational responsibility to apply to all personnel within a company’s
ethics and compliance program.
5. The 2010 amendment also made it possible for companies to have their penalties for
misconduct reduced if their ethics programs met four conditions.
a. The organization itself must have discovered the misconduct before it was discovered
externally.
b. The violation should be reported promptly to regulators
c. Nobody with operational responsibility can be involved in the misconduct.
d. The compliance officer must have direct access to the governing authority to report
misconduct.
F. In 2014 the Federal Sentencing Commission focused attention on the sharing of best practices
among regulatory and law enforcement agencies.
1. Agencies such as the Department of Justice’s Antitrust Division are developing compliance
programs based on aspects of the FSGO’s seven steps for an effective compliance program.
VII. Core or Best Practices
A. The concept of core practices is to focus more on developing structurally sound organizational
practices and structural integrity for financial and nonfinancial performance measures than on an
individual’s morals.
1. Most ethical issues relate to non-financials such as marketing, human resource management,
and customer relationships.
2. Use of gatekeepers is an important part of core practices. Gatekeepers are people who must
trust and be trusted to make business work properly and include accountants, financial rating
agencies, and financial reporting services.
B. Voluntary responsibilities relate to business’s contributions to stakeholders. Voluntary
responsibilities provide four major benefits to society:
Chapter 4: The Institutionalization of Business Ethics 26
1. They improve the quality of life and help make communities places where people want to do
business, raise families, and enjoy life.
2. They reduce government involvement by providing assistance to stakeholders.
3. They develop employee leadership skills.
4. They help create an ethical culture and values that can act as a buffer to organizational
misconduct.
C. Cause-related marketing ties an organization’s product(s) directly to a social concern through a
marketing program.
1. With cause-related marketing, a percentage of a product’s sales is donated to a cause that
appeals to a target market.
2. Cause-related marketing can affect buying patterns if consumers sympathize with the cause, the
brand and cause are perceived as a good fit, and consumers are able to transfer feelings toward
the cause to the brand.
3. A potential problem is that consumers may perceive a company’s cause-related campaign as
merely a publicity stunt, especially if they cannot understand the link between the campaign
and the company’s business practices.
D. Strategic philanthropy is the synergistic and mutually beneficial use of an organization’s core
competencies and resources to deal with key stakeholders so as to bring about organizational and
societal benefits.
1. It uses, as all do, the profit motive, but argues that philanthropy must have at least a long-term
positive impact.
2. Companies that utilize strategic philanthropy recognize that companies do not operate
independently of society, and that improved social conditions could lead to improved economic
benefits.
3. To be successful a strategic philanthropy program should pertain to the mission and operations
of the company.
E. Social entrepreneurship occurs when an entrepreneur founds an organization with the purpose of
creating social value. They desire to find a solution to a social problem rather than to simply earn
profits.
1. These types of organizations, called social enterprises, can be for–profit, non-profit,
government-based, or hybrids.
2. The concept of social entrepreneurship was popularized with the founding of micro-lending
organization Grameen Bank.
3. Even though its mission is social rather than economic, social enterprises use business-like
strategies as well as organizational structures, norms, values, and innovation to reach its social
objectives.
4. The major difference between a social enterprise and strategic philanthropy is that while
strategic philanthropy is strongly integrated into a firm’s operations, the organization is not
necessarily organized around a philanthropic purpose. Social enterprises, though, directly
implement their programs and are organized around achieving social objectives.
VIII. The Importance of Institutionalization in Business Ethics
A. Institutionalization involves embedding values, norms, and artifacts in organizations, industries,
and society.
B. It is important to recognize that institutionalization of business ethics has advanced rapidly over the
last 20 years as stakeholders have recognized the need for improving business ethics.
27 Chapter 4: The Institutionalization of Business Ethics
DEBATE ISSUE: TAKE A STAND
Have your students split into two teams. One team will argue for the first point, and the other will argue
for the opposing view. The purpose is to get students to realize that there are no easy answers to many of
these issues. This debate revolves around advertising from the company POM Wonderful. The FTC sued
POM Wonderful because it was making health claims that pomegranate juice lowers the risk of heart
disease, erectile dysfunction, and prostate cancer. The FTC feel there is not enough evidence to
substantiate these claims. POM, on the other hand, argued that the FTC was trying to infringe on its free
speech rights. The courts upheld the FTC’s verdict, but rejected the FTC’s requirement that companies
had to conduct two clinical trials before communicating any health benefits. It felt that one trial is
sufficient. One team will argue that the FTC’s ruling on two clinical trials is necessary to determine
causality and ensure that consumers are receiving the most accurate information. The other team will
argue that the FTC’s ruling on two clinical trials oversteps its authority because documentation suggests
that pomegranate juice has health benefits and poses no danger to consumers. The instructor might want
to ask students to consider the difference between making health claims on something like pomegranate
juice versus making health claims regarding pharmaceuticals. Is there a difference?
“RESOLVING ETHICAL BUSINESS CHALLENGES” NOTES
Students may identify Bill’s activities as illegal. They should certainly identify his actions as unethical and
grounds for expulsion from the university. However, Ahmed is the one facing the challenge.
Ahmed is a student worker at the university library, and he has access to all library databases, including the
ones reserved only for professors. Bill, a fellow student worker, uses the database access to download music
and movies, all while using a professor’s IP address and logging on as someone else. Ahmed has told Bill he
is not interested and does not want to be involved. Ahmed notices other students approaching Bill before
logging onto library computers, inserting discs, staying a few minutes, and then leaving. One day, Ahmed
finds at his desk an envelope with his name on it, and $500 inside. He suspects Bill but Bill will not
acknowledge leaving the money and will not take it back.
Ahmed is very uncomfortable with the situation. He knew that Bill’s activities were possibly illegal and he
asked not to be involved, but now he has taken money. If he told, would he be a “snitch”? He did not want to
be the one to tell on Bill, but he knew the school could expel Bill. Would the school consider expelling
Ahmed too? What if Ahmed does nothing and the university finds out about Bill’s activities?
Describe the stakeholders involved in this ethical dilemma. What stake do they have in the situation? Are
Bill’s actions an ethical issue, a legal issue, or both?