Chapter one

An overview of business ethics

Definition and nature

Ethics refers to well based standards of right and wrong that prescribe what humans ought to do
in terms of right, obligation, benefit to society, fairness or specific virtues. Ethics is the branch of
philosophy that studies the values and behavior of a person. Ethics studies concepts like good
and evil, responsibility and right and wrong. Ethics can be distinguished in three categories:
normative ethics, descriptive ethics and meta-ethics. Meta-ethics focuses on the issues of
universal truths, ethical judgments and the meaning of ethical terms. Normative ethics can be
used to regulate the right and wrong behavior of individuals. Descriptive ethics, also called
applied ethics, is used to consider controversial issues, such as abortion, animal rights, capital
punishment and nuclear war.
Wrong doing by some businesses has focused public attention and government involvement on
encouraging more acceptable business conduct. Any business decision may be judged as right or
wrong, ethical or unethical, legal or illegal.
1.1. ETHICS AND BUSINESS ETHICS
1.1.1. Meaning of Ethics
The term ‘ethics’ defines the standards that bear on right and wrong issues of society. Business
ethics is thus a set of professional standards, which emphasize principles of honesty and duty to
the business and the general public.
Principles and standardsthat determineacceptable conduct inbusiness. The acceptability of
behaviorin business is determined by customers, competitors, government regulators,interest
groups, and the public, as well as each individual’s personal moral principlesand values. Enron,
one of the largest ethical disasters in the 21st century, isan example. Two former Enron CEOs,
Ken Lay and Jeff Skilling, were found guiltyon all counts of conspiring to hide the company’s
financial condition. The judge inthe case said the defendants could be found guilty of
consciously avoiding knowingabout wrong doing at the company. Many other top executives
including Andy Fastow,the chief financial officer, were found guilty of misconduct and are
serving timein prison. The fall of Enron took many layers of management pushing the envelope

Organizations are expected to establish ethical standards and provide compliance systems to
maintain appropriate conduct within all levels of the organization. Many companies are starting
to recognize that providing jobs and profits are not sufficient criteria to be a responsible member
of society. It is important to be socially responsible—that is, to work with stakeholders such as
employees, customers, communities, and governments to make sure that the company does its
part to minimize negative impacts on society and maximize contributions to important issues that
are being addressed worldwide. Global warming, recycling, and sustainability are social
responsibility issues; employee misconduct in performing business activities is a significant
concern of business ethics.

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The significant principles included in business ethics are:
 Fairness
 Integrity
 Commitment to agreements
 Broad-mindedness
 Considerateness
 Importance given to human esteem and self-respect
 Responsible citizenship
 Attempt to excel
 Accountability
These principles, if strictly pursued, lead to a decent business environment and create healthy
relationships in the organization. However, deviations from these principles can occur due to the
following factors:
 Ignorance and indifference to issues
 Selfishness
 Imperfect reasoning
1.1.2. Concept of Business

A business includes that part of production, which is equally exchanged and results in mutual
benefits to the parties who exchanged goods in the transaction. Business may be defined as an
activity in which different persons exchange something of value, whether goods or services for
mutual gain or profit. It’s an activity of earning income either by production or purchase, sale
and exchange of goods and services to satisfy the needs of people and to earn profit. The
following points may be discussed to reveal the true nature of a business:
Economic activity: Business is an essential economic activity. Profit motive is the key element
that inspires a businessman to work efficiently.
Human activity: Business is a human activity. In this sense, business is considered to be an
economic activity of human beings only. A business is by the people and for the people.
Social process: Business is a social process. All the individuals involved in a business, such as
owners, customers and employees, are an integral part of society. Business has to fulfill its social
responsibilities.
System: A system is a combination of things or parts forming a unitary whole. It is an
established arrangement of components for the attainment of objectives. Similarly, business is a
system consisting of various subsystems that are operated in a balanced and coordinated way.
1.1.3. Types of Business Activities
All human activities concerned with earning money are included under the term business.
Cultivation by a farmer, teaching by a teacher and treatment taken by a patient from a doctor are
also treated as business activities.
There are different types of business activities, which may be classified as follows:

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Industry: An industry includes the activities connected with the production and processing of
goods. Manufacturing enterprises are engaged in the production of goods. These kinds of
industries can be
classified as follows:
 Analytical enterprises: An oil refinery that separates crude oil into petroleum, kerosene
and diesel oil is an analytical concern.
 Synthetic enterprises: An enterprise which combines several materials to produce one
product is a synthetic enterprise. All soap mills and cement factories are synthetic
enterprises.
 Assembling enterprises: All those plants engaged in the production of products, such as
radios, scooters and television sets are assembling enterprises. A few enterprises involved
in mining are involved in mineral resource production, for example, iron ore, coal, gold
and silver.

Commerce: It is the total of all those activities that are engaged in the removal of hindrances of
persons or trade, places or transportation, risk of loss or insurance and time, such as
warehousing, banking and financing of commodities. Commerce can be divided into two
categories: trade and aid to trade. Trade can be further divided into two categories, which are as
follows:
 Internal: This includes the trade that is done with the country, such as wholesale and
retail trade.
 External: This includes the trade that is done with various countries, such as export and
import.
Aid to trade can be divided into transport, banking and insurance.
1.1.4. Characteristics of Business
Business means the creation of utilities. There are many features of business activities and, thus,
the business. The essential characteristics of business may be summarized as follows:
 Exchange or sale: A business includes the sale, purchase and exchange of goods and
services.
 Creation of utilities: A business creates transfers and utilities of goods by making them
available in proper form at the appropriate time and place.
 Social institution: A business deals with the people of society. All the persons engaged
in the business, such as owners, customers, employees and other professionals belong to
the society. A business has to fulfill its social responsibilities towards each part of the
community and has to follow the business ethics as well.
 Profit motive: Business activities are carried out to make profit. A non-profitable
business cannot continue to exist for long. Profits are essential for growth of a business.
 Risk and uncertainty: There are two types of risks in a business. The first type of risk is
floods and thefts. The second type of risk is loss due to fall in demand and labor
trouble.Uncertainty arises because of unpredictability of profit in a business.Profit is such
an element which cannot be predicted in advance.
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  Customer satisfaction: A business always tries to satisfy its customer with better quality
and reasonable prices.
1.2. Responsibilities of a Business towards Various Interest Groups
Interest groups consist of the various persons connected with a business, such as consumers,
shareholders and the community. The responsibilities of a business towards various interest
groups are as follows:
1. Responsibilities towards consumers: A consumer is a person who determines what goods shall
be produced and whether they should be sold in the market or not. Consumers not only
determine the income of the business but also affect the success and survival of the business.
Therefore, a business has some basic responsibilities towards the consumers and these are as
follows:
 To produce those goods that meet the needs of consumers of different tastes, classes
and purchasing power
 To establish the lowest possible price with efficiency and reasonable profit to the
business
 To ensure fair distribution of products among all sections of the consumers
 To make the products more satisfactory to consumers through the study of consumer
needs
 To handle the complaints of consumers more carefully and to analyze them properly
 To answer consumers’ enquiries related to the company, its products and services

2. Responsibilities towards shareholders: The basic responsibility of a business is to ensure the

safety of investment and higher rate of return on the investment. Owners of a business may be
proprietors, partners or shareholders. The interest of shareholders lies in participating in the
management and getting regular dividends at appropriate rates. It is, therefore, the responsibility
of the management to improve communication between the company and its shareholders. This
can be done by providing maximum information to the shareholders through newsletters, annual
reports or by holding the annual general meeting of the company at an appropriate time and
place so that the maximum number of members can come and participate in the discussions.

3. Responsibilities towards community: The management has the responsibility of informing

the community about the organizational policies, activities and contribution towards the
betterment of society. The various other responsibilities towards the community are as follows:
 Financial help to the municipal and district boards for the improvement of housing
conditions
 To help the community by aiding hospitals, schools, colleges, religious institutions, and
so on
 To organize community forums and group discussions to promote better understanding of
national and local affairs
 To encourage sports and provide recreational facilities
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1.3. ETHICS IN THE FUNCTIONAL AREA

Ethical issues can arise in various functional areas of a business such as marketing, research and
development, HRM, production and finance. Ethical issues in all these functional areas must be
controlled or coordinated by the chief executive officer (CEO) of the enterprise.
1.3.1. ETHICS IN MARKETING

Marketing is a technique that is used to attract and persuade customers. Marketing provides a
way in which a product is sold to the target audience. Marketing is a management process that
identifies, anticipates and supplies consumer requirements efficiently and effectively. The main
aim of marketing is to make customers aware of the products and services. It also focuses on
attracting new customers and keeping existing customers interested in the product. The
marketing department consists of various subdivisions, such as sales, after-sales service and
marketing and research.
Figure1 : subdivision of marketing

In the field of sales, the following ethical issues require safeguards against unethical behavior:
 Not supplying the products made by the company as per the order
 Not accepting responsibility for the defective product
 Not giving details about the hidden costs, such as transportation cost, while making the
contract with the client
 Changing the specifications of the product without giving any prior information to the
customer
 Changing the terms of the business without taking any approval from the client
 Delaying the delivery of the goods without giving any proper reason
 Treating two customers differently
 Not providing the after sales service as per the contract
 Selling the same product at different prices to different customers
Advertising and promotion provide the means for communicating with the customer. In the field
of advertising and promotion, the following are examples of unethical communication practices:
 Making false commitments to the customers about the benefits of the product
 Supplying products that are different from those that are advertised
 Giving wrong prices to the customers during advertising
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  Not giving the promised gift in the promotional campaign
 Hiding major flaws of the product
 Providing wrong testimonials about the product to prospective customers
 Not providing the advertised service to the customers as a part of the promotional plans
 Increasing the price of the product before starting its promotional campaign
 Making false references about the competitive products

While selling the product to the customer, a company provides some extended features or
facilities along with the product, such as after-sales service. These facilities are provided to
increase the sale of the product. In the field of after-sales service, the following ethical issues
require safeguards against unethical behavior:
 Using below-standard material for the service and charging for relatively better material
from the customer
 Using outmoded service equipment which can be harmful for the products during service
 Not taking the service calls if the location is not easy to reach, while free service was
promised before the sale of the product
 Making only temporary adjustment in the product, which can last only for a short time or
to make the product useful for the time being
 Not keeping proper service records of major products for future use, as they can help in
easy diagnosis of problem

1.3.2. ETHICS IN HUMAN RESOURCE MANAGEMENT (HRM)

HRM is concerned with the management of the ‘people’ of an organization. The term HRM is
used to refer to the procedures, philosophy, policies, and practices related to the management of
people within an organization. it is responsible for performing various functions like planning,
organizing, directing and controlling of human resources.

General Manager
HRM

Recruitment Training Administration Industrial

Manager Manager Manager Relation

Figure 2: Subdivision of HRM

The following are examples of unethical practices during the recruitment process of a company:
 Recruitment of known persons without assessing their abilities
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  Recruitment on the basis of financial favors
 Recruitment of the relatives of other employees
 Recruitment based on the recommendations of friend, business associates and other
persons close to the leader
 Recruitment of under qualified persons
 Recruitment of overqualified persons
 Recruitment of less acceptable men when there are better suited women available for the
job.
 Employing children below fourteen years for the job
 Giving less than minimum wages fixed by the government
The training manager of the company can also indulge in unethical practices as can be seen from
the following points:
 Arranging training only for favorite employees, whether they deserve it or not
 Employing outsiders for providing training to trainees even when there are several
persons available inside
 Planning and organizing the training programme without even knowing the need for
training
 Organizing training during peak seasons or on days when workload is very high
 Starting training programmes in an ill-prepared manner
 Extending the time of the training programme to allow the trainees to have a relaxed time
 Supplying outmoded and old training materials for the purpose of training
 Experimenting with trainees by asking them to set their own timetable for Training
In the area of administration, the following are the unethical practices the manager can indulge
in:
 Tampering leave records of the employees
 Giving leaves continuously to favourite employees
 Giving promotions to non-eligible persons merely on the recommendations of a friend or
business associate
 Ignoring issues related to the security of the company
 Interference in various activities of the administration from the top management
 Giving the contract for uniforms of the employees to the wrong companies just for the
sake of personal benefits
1.3.3. ETHICS IN FINANCE
Finance is an important element of an organization and it helps in its growth and development.
Finance plays an important role in making resources available in an organization, such as man,
machine, material, market and money. The finance manager of the firm is responsible for
arranging the finances for the firm. The finance manager can raise funds from the following two
sources:
 Internal Sources: Internal sources means the owner’s own funds that are invested as equity
in the organization. In case of small organizations, the owner’s contribution in terms of equity is
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low. Therefore, large amount of money is raised from external sources. The entrepreneur can
raise finance internally from various sources:
 Deposits and loans given by owner
 Personal loan from provident fund and life insurance policy
 Funds accumulated by the retention of profits
 Ploughing back of profits
 External Sources: External sources mean the various financial institutions from where
entrepreneurs can raise funds, such as fixed capital, commercial banks and development banks.
The entrepreneur can raise finance by:
 Borrowing money from friends and relatives
 Borrowing from financial institutions

General Manager
of finance

Finance Accounts Costing Audit

Figure 3: organizational chart for finance function

The finance department of an enterprise is prone to the following unethical practices:

 Overestimating promoters’ capital utilization
 Over budgeting project costs
 Using underhand tactics with the financers to gain benefits for the firm as well as for
themselves
 Purchasing capital equipment at a time when there is no requirement for it
 Selling the capital equipment in order to raise additional and unaccounted funds
 Siphoning funds for the promoter’s personal benefit
 Investing unapproved funds in order to gain extra profits
 Claiming insurance cover for losses that never happened
 Overpricing the current assets in order to gain more working capital than permitted
 Using working capital funds for personal gains

The accounts department of an enterprise is prone to the following types of unethical issues:
 Showing inflated salaries and getting receipts from employees for an amount larger than
what they actually get
 Playing inflated vendor bills in order to get discounts or commissions
 Paying overtime wages when there is no requirement for them
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  Maintaining two different sets of books, one for the management and the other for
income tax
 Refusing to reject unacceptable raw materials when the vendor bills have to be paid
 Delaying the clearance of the bills payable in order to get maximum interest for the
amount to be paid
 Allotting extra travelling allowances to favorite employees
 Showing wrong figures in the monthly trial balances for personal benefits
The following are the unethical practices of the costing manager:
 Reducing manufacturing costs by manipulating work hours
 Ignoring cost of rejects
 Ignoring cost of rework
 Not accounting for man-hours lost due to strikes and absenteeism
 Not accounting for man-hours lost in maintenance work
 Not considering the work stoppages due to change in models
 Ignoring the man-hours lost due to change in the manufacturing process
 Ignoring time lost in failed experimentations
 Not taking into acccount the benefits of economies of sales and experience curve
The following points describe the unethical behavior of the auditing manager:
 Ignoring major deviations from the budgets
 Rejecting the tender having lowest cost among all due to personal reasons
 Helping in hiding black money in order to reduce the tax payable amount
 Ignoring inflated travel bills of selected employees
 Accepting payments made by the directors for personal purchases as official payments
 Approving payments to suppliers without checking bills or deliverables
 Approving the substandard construction made by the constructor and approving their bills
for payment
1.4. IMPORTANCE OF ETHICS IN BUSINESS ENVIRONMENT
An ethical image for a company can bring good will and loyalty among customers and
clients.
The following lists some of the importance of ethical behavior for business organizations.
Ethical Motivation: it protects or improves reputation of the organization by creating an
efficient and productive work environment.
Balance the needs and wishes of stakeholders: it requires business to think about the impact
of its decision on people or stakeholders who are directly or indirectly affected by those
decisions. Helps companies build their image by acting in accordance with values.
Global challenge: business must become aware of ethical diversity in the world because of
increasing globalization. According to resent study, transnational corporations account for
2/3 of world trade.

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 Ethical pay-off: serve to protect the organization from significant risks and help grow the
business. If a company is ethical, it can reduce the violation of rules and regulations there by
reducing risks associated with unethical behavior.
Employee retention: high employee turnover is a cost for companies. Ethical behaviors of
companies help to retain employees in an organization.
Preventing and reduction of criminal penalties: sound ethical programs prevents companies
from engaging in unethical behavior.
Preventing civil law suits: unethical behavior towards employees or customers may create
law suits against companies. It helps companies resolve issues before complaints go outside.
Market leadership: when a company fully integrates its values into its culture, quality arises
due to employees focus on values. Businesses that demonstrate the highest ethical standard
are also the most profitable and successful.

Chapter Two

Ethical principles in Business

2.2. Ethical Concepts

Ethics is the branch of philosophy that is used to evaluate human actions. Some basic ethical
concepts in business are as follows:
 Ethical subjectivism: This concept emphasizes that the ethical choice of the individual
decides the rightness or wrongness of his behavior.
 Ethical relativism: According to this concept, no principle is universally applicable and
so it would be inaccurate to measure the behavior of one society with another’s principles
or standards. Relativism overlooks the fact that there may be enough evidence to believe
that an ethical practice is based on false belief, illogical reasoning, and so on.
 Consequentialism: Consequentialism is based on two ideas: the concept of value and the
maximization of value. If, for example, honesty is considered a value, an act is
considered ethical only if it maximizes this value. An act, which does not maximize the
said value, is not ethically permissible.
 Deontological ethics: This concept stresses that ethical values can be developed from the
concepts of reason as all rational individuals possess the ability to reason. We may, for
example, end up causing pain unknowingly while trying to create happiness. Therefore,
the ethical value of an action cannot be determined by its consequences. Instead, it is in
the motive that lies behind the particular action.
 Ethics of virtue: This concept emphasizes those traits that give the individual a sense of
satisfaction from ethical point of view. Virtuous acts like courage, honesty, tolerance and
generosity are done as a way of living and not by chance.
 Whistle blowing: Whistle blowing refers to the attempt of an employee to disclose what
he or she believes to be illegal behavior in or by the organization. From one point of
view, this seems to deceive the principle of honesty in business ethics, as it is taken for

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 granted that the employees of an organization need to be loyal to its workings. However,
when loyalty to one’s organization in particular is perceived to be harming one’s general
loyalty to mankind, the act of whistle blowing is justified. Failure on the part of the
management of the organization to fulfil its social obligations calls for whistle blowing. It
is the responsibility of the whistle blower to be careful about revealing the organization’s
secrets and to consider the harm it may cause to his colleagues and shareholders.
2.3. Ethical Models
Ethical models can be used to define ethical situations and manage ethical dilemmas that may
occur in the organizations. The Golden Rule Model and The Right-driven or Kantian model are
two operational models that have emerged from the work of philosopher Immanuel Kant.
The Golden Rule Model
This model—originated from the New Testament—specifies people should treat others in the
same manner that they themselves would like to be treated. It is a fundamental principle found in
every culture and religion and it is the most important basis for the modern concept of human
rights. It is also called the ethics of reciprocity as it stimulates an individual to put oneself in the
other person’s shoes and then evaluate how one would wish to be treated in that particular
situation. This proves that this rule is absurd without identifying the receiver and the situation.
The ethics of reciprocity should not be confused with revenge or penalizing justice. The ethics
also mentions that one has the freedom to do anything as long as those activities do not harm
anyone. If this golden rule is applied to every anomaly, then many unethical consequences may
result in causing harm to others and perfectionists may charge others with critical analysis, which
may lead to harassments. Different people have different ideologies, beliefs and may belong to
different cultural heritages. This difference is the reason behind the difference people’s behavior
towards various situations.
The Kantian Model

This model is based on the hypothesis that everybody has some fundamental rights in this ethical
universe. So any action is ethically correct if it reduces the stakeholders’collective violation of
rights. This model willingly provides assistance in the internal audit review and helps in
managerial decision-making. Kant did not believe that any outcome was good from its origin.
According to him good is not always intrinsic. He did not believe in ‘good’ character traits like
ingenuity, intelligence and courage. In fact, he used the term ‘good’ to describe ‘goodwill’, by
which he meant the resolve to perform the act purely in accordance with one’s duty.

If the actions are predetermined then they cannot be described as free and moral. He believed
that to act morally, freedom is required. According to Kant there are two concepts of duty.
According to one concept, duty is just following orders imposed by others. The other concept is
that duty is internal and can be imposed on oneself. He considered that inclinations constitute
motivation whereas others believed that it was the physical world that acted as motivation. But
Kantbelieved that the sources of the physical world might be unreliable, passive andphenomenal.
Sometimes, man’s mind is over-clouded by sorrows due to his lack of sympathy from others but
he still has the power to help those in distress. He no longer needs any support as he is
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sufficiently occupied with his own inclinations, making him indifferent to the sufferings of
others. He becomes adaptive to his sufferings with the help of the patience and endurance he has
developed in due course of time. This begins to show his worth of character and temperament.

Most of us live by rules most of the time. Some of them are called categorical imperatives that
are unconditional commands which bind everyone at all times. There are two types of
imperatives: hypothetical imperative, which is to say that if one wants to achieve success then he
should work in a freeway and not bind himself to his inclinations; and categorical imperative, for
example, the imperative to always tell the truth as it is unconditional and can be applied at all
times.
Kant also introduced maxims, which are subjective rules that guide actions and help an
individual to act according to the relevant description. There is sufficient generality in
description. All actions have maxims like:
 Never lie to your colleagues.
 Never act in a manner that would make your family or organization ashamed of you.
 Always work hard to be the best performer.
2.4. Ethical Corporate Behavior

To understand the term ‘organizational ethics’, one has to first try and understand the two terms
‘organization’ and ‘ethics’. An organization is a collection of individuals with a common mission
while ‘ethics’ may be described as an attempt or endeavor by individuals, to understand what is
‘right’ or ‘wrong’. Ethics is concerned with the critical analysis of situations. Organizational
design and follow a set of core principle or concepts in that attempt to develop ethical corporate
behavior.
Organizational ethics is used to consider the issues of morality and rationality in organizations.
Organizational ethics is completely different from management ethics. Management ethics
focuses on the ethical quality of the decisions and actions taken by managers of an organization.
Thus, management ethics deals with the individuals in the organization and organizational ethics
deals with all the activities of an organization. Therefore, organizational ethics is collective in
scope.
Organizational ethical issues can be handled at three levels. These levels are:
 Corporate mission
 Constituency relations
 Policies and practices

Corporate mission refers to the objectives of an organization that are used to define its ethical
responsibilities. Corporate mission also reflects the ambitions and expectations of the employees.
Employees should be integrated in a good manner to achieve the corporate mission.

Constituency relations define the responsibilities of the elements of an organization. The

elements of an organization may be employees, customers, suppliers, shareholders and the

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general public. These responsibilities must be handled properly to manage the ethical conduct of
business.

Organizational ethics can also be used to evaluate the policies and practices of the organizations.
Public commitment to ethical principles can give way to business and administrative practices.

Organizational ethics also depends on the type of the organization. Organizations can be
classified by considering their economic and ethical concerns. Organizations can be classified
into four types. These are:
Exploitative: Organizations with low economic and ethical concerns are called exploitative
organizations. These organizations utilize child labour and use rivers for dumping wastes to
maximize their profits.
Manipulative: Organizations with high economic performance concerns and low ethical
concerns are called manipulative organizations. These organizations use tax laws, labour laws
and union leaders to maximize profit.
Holistic: Organizations with high ethical concerns and low economic concerns are called holistic
organizations. These organizations spend their money in social and environmental purposes.
Balanced: Balanced organizations have high ethical and economic concerns. These types of
organizations gain profit as well as work for social and environmental purposes.
2.4.1. Corporate code of Ethics
Corporate ethical codes can be defined as the standards and beliefs of an organization. These
standards and beliefs are made by the managers of the organization. These ethical codes can be
used to adjust the thinking and attitude of the individuals in the organization. Ethics codes of
organizations are different from the rules of ethics. Ethical rules are the requirements according
to which an individual acts.

Organizations can handle the issue of ethics by incorporating the code of business conduct in the
corporate structure. These business codes can be used to advise, guide and regulate the behaviour
of the individuals in organizations. Organizations can translate the human core values into
business codes by using some specific guidelines. Many organizations have formulated codes of
ethics for their employees. Most of these codes are very different and some are similar.
These formulated codes of ethics can be used as a tool for developing ethical conduct. Some of
the ethical codes formulated by organizations are:
 Ethical codes for discipline
 Proper code of dressing
 Avoiding abusive language or actions
 Punctuality
 Legalistic ethical codes
 Always following instructions from superiors
 Performance of fair performance appraisals
 Personal and cultural ethical codes

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  Not using official property for personal use
 Performance of good quality of work
 Having initiative
 Conservation of resources and protection of quality of environment
Advantages of a Code of Ethics
Some of the advantages of a code of ethics are:
 Code of ethics can be used to handle outside pressure.
 They can also be used in making overall strategic decisions.
 These codes can be used to define and implement the policies of the organization and
distribute work between the employees.
 Code of ethics can be used to optimize the public image and confidence of the
organization.
 They can be used to increase the skills and knowledge of the individuals.
 Code of ethics can also be used to respond to the different issues of stakeholders.
 These codes of ethics can be used to discourage improper requests from employees.
 They can also strengthen the enterprise system.

Code of ethics exists in two types

 Principle based statements

 Policy based statements

Principle based: designed to affect corporate culture. It defines fundamental values and contains
general language about company responsibilities, quality of product and treatment of employees.

Policy based: outline the procedures to be used in specific ethical situations. Example marketing
practice, conflict of interest

2.5. Ethical principles

The following principles relate to all professionals and must be strictly followed while providing
professional service to society:

Integrity: imposes an obligation on all professional accounts to be straight forward and honest in
all professional and business relationships. It implies fair dealing and truthfulness. Their work
must be uncorrupted by self-interest and not be influenced by the interest of other parties.

Objectivity: imposes an obligation not to compromise their professional or business judgment

because of bias, conflict of interest or undue influence of other. A professional accountant shall
not perform a professional service if a circumstance or relationship biases or influences the
accountants’ professional judgment with respect to that service.

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Professional competence and due care: imposes the following obligations on all professional
accountants:

 To maintain professional knowledge and skill at the level required to ensure that clients
or employers receive competent professional service
 To act diligently in accordance with applicable technical and professional standards when
providing professional service.

Confidentiality: all unpublished information about a clients or employers affair is confidential.

Principle of confidentiality imposed an obligation on all professional accountants to refrain from:

a. Disclosing outside the firm information acquired as a result of professional and business
relationship without proper and specific authority or unless there is legal or professional
right or duty to disclose
b. Using confidential information to their personal advantage or the advantage of their
parties.

Disclosure of confidential information is appropriate if; (a) Disclosure is permitted by law and is
authorized by the client or employer. Disclosure is required by law if;

 Production of documents or provision of evidence in the course of legal proceedings

 Disclosure to the public authority of infringements of the law

Professional Behavior: imposes on all professionals to comply with relevant laws and
regulations and avoid any action that the professional knows or should know may discredit the
profession. Professionals should avoid actions that adversely affect the good reputation of the
profession. Example; make exaggerated claims; make un-substained comparisons to the work of
others.

2.6. Theories of business ethics

1. Stakeholder theory: theory of organizational management and business ethics that

addresses morale and values in managing an organization. It argues there are other parties
than shareholders that a company needs to consider in its decisions and actions. It is
based on the assertion that maximizing wealth for shareholders fails to maximize wealth
for society and all its members.
2. Social Contract Theory: social contract theory sees society as a series of social
contracts between members of society and society itself. There is a school of thought
which sees social responsibility as a contractual obligation the firm owes to society. An
integrated social contract theory was developed by Donaldson and Dunfee as a way for
managers make ethical decision making, which refers to macrosocial and microsocial
contracts. The former refers to the communities and the expectation from the business to

15
 provide support to the local community, and the latter refers to a specific form of
involvement.
3. Legitimacy Theory:Another theory reviewed in the corporate governance literature is
legitimacy theory. Legitimacy theory is defined as “a generalized perception or
assumption that the actions of an entity are desirable, proper, or appropriate with some
socially constructed systems of norms, values, beliefs and definitions. Similar to social
contract theory, legitimacy theory is based upon the notion that there is a social contract
between the society and an organisation. A firm receives permission to operate from the
society and is ultimately accountable to the society for how it operates and what it does,
because society provides corporations the authority to own and use natural resources and
to hire employees.

Traditionally profit maximization was viewed as a measure of corporate performance.

But according to the legitimacy theory, profit is viewed as an all-inclusive measure of
organizational legitimacy. The emphasis of legitimacy theory is that an organization must
consider the rights of the public at large, not merely the rights of the investors. Failure to
comply with societal expectations may result in sanctions being imposed in the form of
restrictions on the firm's operations, resources and demand for its products. Much
empirical research has used legitimacy theory to study social and environmental
reporting, and proposes a relationship between corporate disclosures and community
expectations.

Chapter Four

An Overview of Corporate Governance

4.1. Definition

Corporate governance is defined as an act of controlling, directing and

evaluating the activities of an organization. The structure of corporate
governance specifies that the others taking part in the organization, such as
the board managers, board of directors, shareholders and other stakeholders
must be provided with some rights and responsibilities. Corporate governance
helps the organization achieve the goals and objectives in a desired manner.

Corporate governance has achieved a great deal of success in attracting public

interest because corporate governance gives importance to the economic
health of the corporation and the society as a whole. However, corporate
governance covers a wide variety of the distinct economic phenomenon.
Therefore, many people have given different definitions of corporate
governance. A few definitions of corporate governance are as follows:

16
According to Shleifer and Vishny, ‘Corporate governance deals with the ways
inwhich suppliers of finance to corporations assure themselves of getting a
return on their investment.’
An article from Financial Times has defined corporate governance as
‘therelationship of a company to its shareholders or, more broadly, as its
relationship to society’.
According to the J. Wolfensohn, ‘Corporate governance is about
promotingcorporate fairness, transparency and accountability.’
4.2. The Need for Corporate Governance

There are various reasons for the need for corporate governance in an
organization. These are:

 A corporation, which is a union of many stakeholders, such as

employees, customers, investors, vendors, and so on, must be fair
and transparent to its stakeholders in all its dealings. It is very
important in today’s globalized business world, where corporations
require to have access to global pools of capital attract and retain the
best human resource from all parts of the globe. If a corporation does
not take up and show ethical conduct, it is not considered to be
successful.
 Corporate governance covers ethical conduct in business, the code of
values and principles that helps an individual to choose between
right and wrong or make the right selection from the options or
alternatives provided. Managers decide on certain actions on the
basis of an principles that are governed by the culture, context and
values of an organization. An organization that follows ethical values
feel that it is better for the business, as it helps in the long run and
the stakeholders observe that the management is running the
organization in the desired way.
 It is beyond the sphere of law, i.e., it stems from the background and
outlook of the management and cannot be regulated by legislation
alone. It deals with running the affairs of a company in such a way
that it is fair to all the stakeholders and that its dealings benefit the
greatest number of stakeholders. It is about honesty, integrity and
responsibility. Laws should set up a common framework to maintain
standards. Since substance is very much linked with the mindset
and ethical standards of management, it shall in the end lay down
the creditability and integrity of the process.

17
 Corporations should realize that it is necessary for all the
stakeholders to cooperate in order to facilitate development. Such
cooperation andsupport can only be possible by adhering to the best
practices of corporate governance. In this context, management has
to take the responsibility of the shareholders at large and stop any
unbalanced benefits of the varied sections of the shareholders.
 The economic competence of a company can be improved through
corporate governance. Corporate governance also ensures that
corporations consider the interests of a wide range of constituencies
and also of the communities within which they function. Corporate
governance also makes sure that the boards of directors are
responsible to the shareholders. This even helps to ensure that
corporations work for the benefit of the society at large, including the
society’s concerns about labour and environment
 If the execution of good governance fails, heavy losses can result in
terms of cost other than regulatory problems. Many organizations that
do not give due importance to corporate governance end up paying a
large risk premium while contending for scarce capital in the public
markets. Of late, stock market analysts have started realizing,
accepting and appreciating the relationship between returns and
corporate governance.
 The confidence of both foreign and domestic investors is maintained
and upheld due to the trustworthiness that comes from good
measures of corporate governance. The cost of capital should be
brought down so that more long-term investment is attracted.
 Often, importance and attention is given to corporate governance in
times of financial crisis. In the US, when scandals disturbed the
otherwise calm and contented corporate environment, new initiatives
thrown up by them led to fresh debates in Asia and the European
Union. With many instances of corporate misdemeanour coming into
limelight, the emphasis now is on compliance with substance, rather
than on form. It has also brought to the fore the need of intellectual
honesty and integrity. The financial and other disclosures made by
firms are only as good as the people who make it.

 Corporate governance is aimed at increasing the long-term value of

an organization for not only its shareholders, but also partners.

18
4.3. Roles and Responsibilities of Corporate Governance Actors

4.3.1 Role of the Board of Directors in Corporate Governance

Board of directors is made up of individuals elected by a corporation's

shareholders to oversee the management of the corporation. An organization
allows different individuals or parties to add to the capital, expertise and their
knowledge so that the organization can function efficiently without facing any
difficulties. There are various participants in the organization such as investors
and shareholders. They do not participate in the operations of the organization.
Their main interest is to have a proportion of the share in the income of the
organization. The shareholders and investors have the right to elect the board
of directors of an organization in order to represent and protect their interests.
The board of directors has the power and duty to form the corporate policies of
an organization. Therefore, the board of directors has the powers to take
certain decisions, which can in turn affect the long-run performance of the
corporation. It means that the board of directors has a very significant function
in the working of the business as it also oversees the top management of the
organization.
The duties and rules that the board of directors has to follow are plainly laid
down by the organization. It includes monitoring the performance of the
company and its management and approving important business policies. The
board of directors receives regular reports on the financial position of the
organization, key areas of the organizations’ operations and other issues.

Responsibilities of the board of directors

The various responsibilities of the board of directors are as follows:

 Providing continuity to the organization by setting up the organization as

per the legal requirements and effectively advertising its products and
services to the customers.
 Selecting and appointing a chief executive whose basic duty is to review
and evaluate the performance of the organization and offering
administrative guidance to the organization.
 Governing the organization by setting up broad policies and objectives
and monitoring whether the organization follows the policies.
 Acquiring the resources and finance for effectively running the day-to-
day operations of the organization.
 The board of directors must be accountable to the public for the products
and services of the organization, which include approving the budget and
formulating the policies related to the contracts for producing a product.
19
 4.3.2. Role of top management in corporate governance

The board of directors occupies the top management whose prime concern is
strategic management of the organization. The top management is supervised
by the president in coordination with the vice-president of the organization

Responsibilities of Top Management

The responsibility of the top management is to get the objectives of an

organization accomplished within the organization and in the industry. Thus,
the role and responsibility of the top management is multifaceted and is
directed towards the welfare of the organization. The duties of the top
management are distinct as they may vary from organization to organization.
The development of the tasks of the top management are developed by the
analysis of objectives, strategies and fundamental activities of the organization
The top management should primarily support two critical responsibilities,
crucial for strategic management to be effective. The two responsibilities are as
follows:

Provision of executive leadership and strategic vision: Executive leadership

means directing the activities of the organization to accomplish its objectives.
Strategic vision refers to the description of the capabilities of the organization,
which is generally described in the mission statement. The top management
defines the strategic vision of the organization to the employees. The
enthusiasm and passion for the organization comes from the top management.
Top management must have clear strategic vision, enthusiasm and dynamism.
They possess three important characteristics that enable them to command
respect and alter the process of strategy formulation and its implementation:

 Articulation of strategic vision with strategy: The top management

visualizes the organization as what it is expected to become and not to
what it already is. He adds a new aspect to the strategic activities that
enables the employees to refresh their working habits to attain new
heights.
 Makes guidelines for others to identify and follow: The behavior of the top
management towards the values concerning the objectives of the
organization should be clear and must be communicated constantly
through his work and activities. If the top management behaves
responsibly then the employees trust in him and get inspired to work
with the same enthusiasm
 Communicate high performance level and confidence to the followers:
Leadership of the managers of an organization involves setting up of
20
 goals for the employees accompanied with challenges and training his
people for the same. He should provide his workforce with power and
resources before setting targets.

Manage strategic planning process: In an organization, the characteristics of

strategic planning are same as that in learning organizations where ideas can
come from any division of the organization. Top management should encourage
the planning process so that strategic management can work effectively in the
organization. In multidivisional organizations, the top management should ask
its units to prepare a strategy for themselves, which should be considered
before planning and formulating the final strategic plan. Such practices make
the work atmosphere dynamic and encourage the workforce to work according
to their potential. The other method is to provide the workforce units with the
mission statement and objectives and allow them to formulate strategies
accordingly. Regardless of the approach taken to formulate a strategy, the
board of directors expects the top management to prepare such a strategic plan
that works well with the organizational objectives. Therefore, the top
management’s responsibilities include evaluating each unit’s proposed
objective, planning strategies to seek how effectively it satiates the
organizational goals with respect to available resources and providing feedback.

4.3.3. Role of the CEO in Corporate Governance

Any action that is taken by any individual in the organization can affect the
firm’s operations to a great extent. For example, if any individual is appointed
as a team leader, then he has the responsibility to take certain decisions that
would help in the progress of his entire team. If an individual is provided with
any sort of power, then it is up to him to use it for the benefit of the
organization or he can use the powers to fulfil his own requirements. It is the
same for CEOs in an organization. Organizations achieve great success in
business because of their chief executive officer (CEO). The CEO oversees the
company's finances and strategic planning.

The powers of a CEO can greatly influence the working of an organization.

Therefore, it is very important to know about the powers of the CEO and how
his powers can ultimately influence the results of an organization. The CEO of
an organization has a very important role to play in certain areas, which are:

Personal action
Handling of organizational politics
Role as a negotiator
Role as a communicator
21
 Role as a role model
Personnel action

The CEO of a firm has the power to take personnel actions in a manner that is
beneficial for an organization in the following ways:

Ordering the employees: A CEO of an organization uses his authority to order

the employees. The employees of an organization are directed by a CEO to
perform certain tasks at a defined period of time. If any of the employees are
disobedient or their actions are not very good, then the CEO has an authority
to throw him out of the organization. The ordering of employees is done to
achieve the goals and objectives of an organization.

The ordering method, which is employed by the CEO, provides certain benefits
to the organization. When there is a need of any structural changes to be made
in the organization, then the ordering method is very helpful. For example, if
an organization decides to implement a new and improved structure for
managing the performance of the employees in the organization, then the CEO
has to just give instructions and train employees in operating the new system.

Making cultural changes: It is very difficult for a CEO to change the culture of
an organization. Cultural changes are those changes that are deeply rooted
among the employees such as collective thinking, and mindsets, which have
become a part of the organizational’s working environment. For bringing about
cultural change in the organization, just ordering the employees will not help
the CEO. A CEO has to use the right approach for bringing about a change in
the cultural mindset of the employees. For bringing about a change, a CEO
must look after certain agendas and the communication network of an
organization. If he finds any defects in the agendas or the communication
network, then he must rectify those defects in order to make cultural changes
among the employees and achieve the goals and objectives of the organization.

Persuading the employees: A CEO of an organization persuades the

employees to perform certain tasks in an efficient manner. If the employees
find it difficult to perform certain tasks, then the CEO looks after the problems
that the employees face. After looking at all the difficulties, a CEO must
persuade the employees to work better and direct their efforts towards the
achievement of the goals. A CEO also negotiates with the employees if there is a
situation of dispute between the employees and the management.

Inducing the employees: A CEO also induces the employees to work towards
the attainment of the goals and objectives of an organization. There may be

22
certain employees in an organization that may not be performing well in
accordance with the expectations of the organization.A CEO can induce the
employees by asking them to change their ways of working and thinking, so
that organizational goals can be achieved in a desired manner.

Handling of organizational politics

The CEO must accept the fact that politics is certain in every organization.
Pfeffer has defined politics as ‘those activities taken within organizations to
acquire, develop and use power and other resources to obtain one's preferred
outcomes in a situation in which there is uncertainty or dissension about
choices’.

An individual, subunit or department may have power within an

organizational context at some period of time; politics involves the exercise of
power to get something accomplished, as well as those activities, which are
undertaken to expand the power already possessed, or the scope over which it
can be exercised.

Therefore, it is clear that political behaviour is designed and started to

surmount opposition or resistance. If there is no opposition, there is no need
for politics. Opposition and resistance are bound to occur in all organizations
because of severe competition for scarce resources. Five major reasons that
have strong influence on the political orientation of organizations are:

Scarcity of resources: Any person or subunit having control over the

allocation of scarce resources; their power and political influence play an
important part in how these resources will be distributed to various
departments, rather than fulfilling their own needs.

Non-programmed decisions: Non-programmed decisions involve unique

problems that cannot be solved by structured methods and procedures. These
unique problems involve many factors and variables that are ambiguous in
nature leaving room for political planning by those who have the knowledge
and techniques to successfully confront and solve such complex problems.
Such non-programmed decisions are likely to be made in the areas of strategic
planning, mergers and acquisitions and policy changes.

Ambiguous goals: When the goals of an organization are clearly defined and
each member of the organization is aware of these goals and is also aware of
his role in contributing towards the achievement of such goals, then there are
limited grounds for political influences. However, when the goals of a

23
department or the entire organization are ambiguous then there is more room
available for playing politics.

Technology and environment: An organization must have the ability to

appropriately respond to an external environment that is highly dynamic and
generally unpredictable. The organization must adequately adapt tocomplex
technological developments that are changing day by day. Therefore, the
political behaviour in organizations is increased when the internal technology
is complex and when the external environment is highly unstable.

Organizational change: Whenever there are changes in the

organizational structure or the rearrangement of organizational policies,
individuals in powerful positions have the opportunity to play political games.
These changes may include restructuring of a division or creation of a new
division, personnel changes and introduction of a new product line. All these
changes are invitations to political processes when various individuals and
groups try to control the given situation.

Role as a negotiator

The CEO performs the role of a negotiator in which he has the full support of
an organization. A CEO negotiates the problems that the employees face in
performing the tasks in a specified period of time. If the CEO is busy
inperforming some other tasks, then the role of negotiator can be delegated
between the general manager and any other departmental head. A CEO must
keep some factors in mind before performing the negotiations:

If the demands of the two persons cannot be met, then the person who is
shouting should not get what he wants. If the demand of a person who was
shouting more is fulfilled then it will lead to the belief that the demands of the
person who shouts will be fulfilled. Therefore, to mitigate these problems, a
CEO must patiently hear the problems or demands of the employees and
must arrive at a situation that is acceptable by all wholeheartedly.

A CEO must negotiate the problems in such a manner that the employees of
an organization agree to increase the productivity and reduce the
absenteeism.

Role as a communicator

A CEO plays the role of a communicator in an organization. It is an important

duty of a CEO to communicate the organizational mission, vision, goals and
objectives to the employees. The CEO, while playing the role of communicator,

24
must listen to the employee’s complaints and problems. A CEO must
understand the problem first and then respond in a positive manner to the
satisfaction of the employees who are facing the problem. Right
communication given correctly at the desired time can motivate the employees
and can charge them to perform the most difficult tasks with great ease.

Role as a role model

The CEO of an organization sometimes becomes a role model for the

employees of the organization. The employees try to emulate the working style
of the CEO. For example, if a CEO of an organization comes late, then the
employees will follow him and they will also start coming late. On the other
hand, if a CEO is punctual, then the employees will also be punctual.
Therefore, the CEO has a great deal of influence on the employees and he
must remain perfect in his actions.

4.3.4. Managerial Roles in Corporate Governance

The managers of an organization also play a very important role in the success
of an organization and corporate governance. An organization must examine
the roles that the managers are expected to perform. Henry Mintzberg
developed these roles in the late 1960s after a careful study of executives at
work. All these roles in one form or another deal with people and their
interpersonal relationships. These managerial roles are divided into three
categories. The first category of interpersonal roles arises directly from the
manager’s position and the formal authority bestowed upon him. The second
category of informational roles is played as a direct result of interpersonal
roles and these two categories lead to the third category, that of decisional
roles.

FORMAL POSITIONAL AUTHORITY

Interpersonal roles
Figurehead
Leadership
Liaison

Informational role
Monitor
Disseminator
Decisional roles
Spokesperson
Entrepreneur 25
Conflict handler
Resource allocator
Negotiator
 Figure 1 : various managerial roles

Interpersonal roles

Managers spend a considerable amount of time in interacting with other

people, both within their own organizations as well as outside. These people
include peers, subordinates, superiors, suppliers, customers, government
officials and community leaders. All these interactions require an
understanding of interpersonal relations. Studies show that interacting
with people takes up nearly 80 per cent of a manager’s time. These interactions
involve the following three major interpersonal roles, which are:

Figurehead: Managers act as a symbolic figurehead performing social or

legal obligations. These duties include greeting visitors, signing legal
documents, taking important customers to lunch, attending a subordinate’s
wedding and speaking at functions in schools and churches. All these,
primarily, are duties of a ceremonial nature but are important for the
smooth functioning of an organization.

Leader: The influence of a manager is most clearly seen in his role as a leader
of the unit or organization. A manager is responsible for the activities of his
subordinates, he must lead and coordinate their activities in meeting task-
related goals and he must motivate them to perform better. He must be an
exemplary leader so that his subordinates follow his directions and
guidelines with respect and dedication.

Liaison: In addition to their constant contact with their own subordinates,

peers and superiors, the managers must maintain a network of outside
contacts in order to assess the external environment of competition, social
changes or changes in governmental rules, regulations and laws. In this role,
the managers build up their own external information system. In addition,
they develop networks of mutual obligations with other managers in the
organization. They also form alliances to win support for their proposals or
decisions. The liaison with external sources of information can be developed by
attending meetings and professional conferences, by personal phone calls,
trade journals and by informal personal contacts within outside agencies.

Informational roles

26
By virtue of his interpersonal contacts, a manager emerges as a source of
information on a variety of issues concerning the organization. In this
capacity of information processing, a manager executes the following three
roles:

 Monitor: Managers are constantly monitor and scan their

environment,both internal and external, collect and study information
regarding theirorganization and the outside environment affecting their
organization.This can be done by reading reports and periodicals, by
asking theirliaison contacts and through gossip and speculation.

 Disseminator of information: Managers must transmit the

informationregarding changes in policies or other matters to their
subordinates, theirpeers and to other members of the organization. This can be
done throughmemorandums, phone calls, individual meetings and group
meetings.

 Spokesperson: A manager has to be a spokesman for his unit and

herepresents his unit in either sending relevant information to people
outsidehis unit or making some demands on behalf of his unit. This may be in
theform of the president of the company making a speech to a lobby onbehalf
of an organizational cause or an engineer suggesting a productmodification to a
supplier.

Decisional roles On the basis of the environmental information received, a

manager must make decisions and solve organizational problems. In that
respect, a manager plays four important roles, which are:

 Entrepreneur: As entrepreneurs, managers are continuously involved in

improving their units and facing dynamic technological challenges. They
are constantly on the lookout for new ideas for product improvement or
products addition. They initiate feasibility studies, arrange for capital for new
products if necessary and ask for suggestions from the employees for ways to
improve the organization. This can be achieved through suggestion boxes,
holding strategy meetings with project managers and research and
development personnel.

 Conflict handler: Managers are constantly involved as arbitrators in

solving differences among the subordinates or the employee’s conflicts
with the central management. These conflicts may arise due to demands
for higher pay or other benefits or these conflicts may involve outside forces
such as vendors increasing their prices, a major customer going bankrupt or

27
unwanted visits by governmental inspectors. Managers must anticipate such
problems and take preventive action if possible or take corrective action once
the problems have arisen. These problems may also involve labour disputes,
customer complaints, employee grievances, machine breakdowns, cash
flow shortages and interpersonal conflicts.

 Resource allocator: The third decisional role of a manager is that of a

resource allocator. Managers must establish priorities among various
projects or programs and make budgetary allocations to the different
activities of the organization based upon these priorities. They assign personnel
to jobs, allocate their own time to different activities and allocate funds for new
equipment, advertising and pay raises.

All these roles are important in a manager’s job and are interrelated even
through some roles may be more influential than others, depending upon the
managerial position. For example, sales managers may give more importance to
interpersonal roles, while the production managers may give more importance
to decisional roles. The traits of effective managers are their ability to recognize
the suitable roles to play in each situation and the flexibility to change roles
when required. However, managerial effectiveness is determined by how well
the decisional roles are performed by the manager in the organization.

.
Chapter five

Principle and theories of corporate governance

5.1. Principles of Corporate Governance

The Cadbury Reportwhich was released in the UK in 1991 outlined that

"Corporate governance is the system by which businesses are directed and
controlled." Good corporate governance is a key factor in underpinning the
integrity and efficiency of a company. Poor corporate governance can weaken a
company’s potential, can lead to financial difficulties and in some cases can
cause long-term damage to a company’s reputation.

A company which applies the core principles of good corporate governance;

fairness, accountability, responsibility and transparency, will usually
outperforms other companies and will be able to attract investors, whose
support can help to finance further growth.

Fairness

28
Fairness refers to equal treatment.For example, all shareholders should
receive equal consideration for whatever shareholdings they hold. In the UK
this is protected by the Companies Act 2006 (CA 06). However, some
companies prefer to have a shareholder agreement, which can include more
extensive and effective minority protection. In addition to shareholders, there
should also be fairness in the treatment of all stakeholders including
employees, communities and public officials. The fairer the entity appears
to stakeholders, the more likely it is that it can survive the pressure of
interested parties.

Accountability

Corporate accountability refers to the obligation and responsibility to give

an explanation or reason for the company’s actions and conduct. In brief:

 The board should present a balanced and understandable assessment of

the company’s position and prospects;
 The board is responsible for determining the nature and extent of the
significant risks it is willing to take;
 The board should maintain sound risk management and internal control
systems;
 The board should establish formal and transparent arrangements for
corporate reporting and risk management and for maintaining an
appropriate relationship with the company’s auditor, and
 The board should communicate with stakeholders at regular intervals, a
fair, balanced and understandable assessment of how the company is
achieving its business purpose.

Responsibility

The Board of Directors are given authority to act on behalf of the

company. They should therefore accept full responsibility for the powers
that it is given and the authority that it exercises. The Board of Directors
are responsible for overseeing the management of the business, affairs of the
company, appointing the chief executive and monitoring the performance of the
company. In doing so, it is required to act in the best interests of the
company.

Accountability goes hand in hand with responsibility. The Board of

Directors should be made accountable to the shareholders for the way in which
the company has carried out its responsibilities.

Transparency
29
A principle of good governance is that stakeholders should be informed
about the company’s activities, what it plans to do in the future and any
risks involved in its business strategies.Transparency means openness, a
willingness by the company to provide clear information to shareholders
and other stakeholders. For example, transparency refers to the openness
and willingness to disclose financial performance figures which are truthful
and accurate.

Disclosure of material matters concerning the organization’s performance

and activities should be timely and accurate to ensure that all investors have
access to clear, factual information which accurately reflects the financial,
social and environmental position of the organization. Organizations should
clarify and make publicly known the roles and responsibilities of the board and
management to provide shareholders with a level of accountability.
Transparency ensures that stakeholders can have confidence in the
decision-making and management processes of a company.

Apart from these, the other principles of corporate governance are as follows:

Rights and equitable treatment of shareholders: The organizations must

acknowledge the rights of the shareholders and they must help the
shareholders in exercising their rights effectively. Shareholders must also be
encouraged to participate in the general meetings of an organization.

 Interests of other stakeholders: It is the duty of an organization to

recognize the legal and other obligations of certain stakeholders.

 Role and responsibilities of the board: In order to deal with various issues
of a business, an organization needs a wide range of skills among the members
of the board. The members of the organization must work with great
responsibility.

 Integrity and ethical behavior: In order to promote ethical and responsible

decision-making, organizations must develop a code of conduct for the
directors of an organization.

 Disclosure and transparency: The roles and duties of directors must be

clearly defined by an organization. Organizations must implement certain
procedures in order to verify and safeguard the integrity of the organization. An
organization must disclose the financial information to investors and
shareholders.

30
5.2. Corporate Governance Theories

The progression of theories or models of corporate governance, it is one of the

new dimensions taken in a very crux of social ethics that is minimal and profit
making took center stage. In this competitive world, companies are trying to
inculcate the wisdom of good governance into their corporate organization. The
ultimate theories in corporate governance started with the agency theory,
extended into stewardship theory and stakeholder theory and evolved to
resource dependency theory, political theory, legitimacy theory and social
contract theory. However, these theories discourse the cause and consequence
of variables, such as the formation of board structure, audit committee,
independent non-executive directors and the duties of upper management and
their organizational and social responsibilities rather than its regulatory
structures

5.2.1. Agency theory

Much of the research into corporate governance derives from agency theory.
Since the early work of Berle and Means in 1932, corporate governance has
focused upon the separation of ownership and management which results in
principal-agent problems arising from the dispersed ownership in the modern
corporation. They regarded corporate governance as a mechanism where a
board of directors is a crucial monitoring device to minimize the problems
brought about by the principal-agent relationship. In this context, agents are
the managers, principals are the owners and the boards of directors act as the
monitoring mechanism. Corporate governance attributes two factors to agency
theory. The first factor is that corporations are reduced to two participants,
managers and shareholders whose interests are assumed to be both clear and
consistent. A second notion is that humans are self-interested and disinclined
to sacrifice their personal interests for the interests of the others.

According to the perspective of agency theory the primary responsibility of

the board of directors is towards the shareholders to ensure
maximization of shareholder value. The focus of agency theory of the
principal and agent relationship (for example shareholders and corporate
managers) has created uncertainty due to various information asymmetries.
The separation of ownership from management can lead to managers of firms
taking action that may not maximize shareholder wealth, due to their firm
specific knowledge and expertise, which would benefit them and not the
owners.

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Arising from the above is the agency problem on how to induce the agent to act
in the best interests of the principal. This results in agency costs, for example
monitoring costs and disciplining the agent to prevent abuse.Agency cost is
defined as the sum of monitoring expenditure by the principal to limit the
irregular activities of the agent.

The agency model assumes that individuals have access to complete

information and investors possess significant knowledge of whether or not
governance activities conform to their preferences and the board has
knowledge of investors’ preferences. Therefore according to the view of the
agency theorists, an efficient market is considered a solution to mitigate
the agency problem, which includes an efficient market for corporate
control, management labour and corporate information.

5.2.2. Stakeholder theory

This theory centers on the issues concerning the stakeholders in an institution.

It stipulates that a corporate entity invariably seeks to provide a balance
between the interests of its diverse stakeholders in order to ensure that
each interest constituency receives some degree of satisfaction.However,
there is an argument that the theory is narrow because it identifies the
shareholders as the only interest group of a corporate entity. However, the
stakeholder theory is better in explaining the role of corporate governance than
the agency theory by highlighting different components of a firm.

With an original view of the firm the shareholder is the only one recognized by
business law in most countries because they are the owners of the companies.
In view of this, the firm has a fiduciary duty to maximize their returns and put
their needs first. However, this model addresses the needs of investors,
employers, suppliers and customers. Pertaining to the scenario above,
stakeholder theory argues that the parties involved should include
governmental bodies, political groups, trade associations, trade unions,
communities, associated corporations, prospective employees and the general
public. In some scenarios competitors and prospective clients can be regarded
as stakeholders to help improve business efficiency in the market place.The
activities of a corporate entity impact on the external environment requiring
accountability of the organization to a wider audience than simply its
shareholders.

The theory differentiates among stakeholder types as: consubstantial,

contractual and contextual stakeholders.Consubstantial stakeholders are
the stakeholders that are essential for the business’s existence (shareholders
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andinvestors, strategic partners, employees). Contractual stakeholders, as
their name indicates, have some kind of a formal contract with the business
(financial institutions, suppliers and sub-contractors, customers). Contextual
stakeholders are representatives of the social and natural systems in which
the business operates and play a fundamental role in obtaining business
credibility and, ultimately, the acceptance of their activities (public
administration, local communities, countries and societies, knowledge and
opinion makers)

5.2.3. Resource Dependency Theory

The basic proposition of resource dependence theory is the need for

environmental linkages between the firm and outside resources. In this
perspective, directors serve to connect the firm with external factors by co-
opting the resources needed to survive. Thus, boards of directors are an
important mechanism for absorbing critical elements of environmental
uncertainty into the firm. Environmental linkages or network governance could
reduce transaction costs associated with environmental interdependency. The
organization’s need to require resources and these leads to the development of
exchange relationships or network governance between organizations. Further,
the uneven distribution of needed resources results in interdependence in
organizational relationships. Several factors would appear to intensify the
character of this dependence, e.g. the importance of the resource(s), the
relative shortage of the resource(s) and the extent to which the
resource(s) is concentrated in the environment.

Additionally, directors may serve to link the external resources with the
firm to overcome uncertainty, because managing effectively with uncertainty
is crucial for the existence of the company. According to the resource
dependency rule, the directors bring resources such as information,
skills, key constituents (suppliers, buyers, public policy decision makers,
social groups) and legitimacy that will reduce uncertainty. Consider the
potential results of connecting the firm with external environmental
factors and reducing uncertainty is decrease the transaction cost
associated with external association. This theory supports the appointment
of directors to multiple boards because of their opportunities to gather
information and network in various ways.

5.2.4. Stewardship Theory

In contrast to agency theory, stewardship theory presents a different model of

management, where managers are considered good stewards who will act
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in the best interest of the owners. The fundamentals of stewardship theory
are based on social psychology, which focuses on the behaviour of executives.
The steward’s behaviour is pro-organizational and collectivists, and has
higher utility than individualistic self-serving behavior and the
steward’s behavior will not depart from the interest of the organization
because the steward seeks to attain the objectives of the organization.
According to Small man (2004) where shareholder wealth is maximized,
the steward’s utilities are maximized too, because organizational success
will serve most requirements and the stewards will have a clear mission. He
also states that, stewards balance tensions between different beneficiaries
and other interest groups. Therefore stewardship theory is an argument put
forward in firm performance that satisfies the requirements of the interested
parties resulting in dynamic performance equilibrium for balanced governance.

Stewardship theory sees a strong relationship between managers and the

success of the firm, and therefore the stewards protect and maximise
shareholder wealth through firm performance. A steward who improves
performance successfully, satisfies most stakeholder groups in an organization,
when these groups have interests that are well served by increasing
organisational wealth. When the position of the CEO and Chairman is held by
a single person, the fate of the organization and the power to determine
strategy is the responsibility of a single person. Thus the focus of
stewardship theory is on structures that facilitate and empower rather
than monitor and control. Therefore stewardship theory takes a more relaxed
view of the separation of the role of chairman and CEO, and supports
appointment of a single person for the position of chairman and CEO and a
majority of specialist executive directors rather than non-executive directors.

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