First, in your initial post, briefly share your thoughts on why you have joined us and what your short- and long-term goals are regarding financial management. Next, read Chapter 1 of your textbook and the article New Directions in Corporate Governance and Finance: Implications for Business Ethics Research, and in your initial post, address the following:
- How did the troublesome situations develop?
- Why have they so permeated the organization and business environment?
- What are the implications of these unfortunate ethical practices for the organization?
- What can be done to control and reduce these practices, and to ensure the organization is worry-free?
Please read the article and answer these questions. The words should be in 2-3 pages in APA style.
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New Directions in
Corporate Governance and Finance:
Implications for Business Ethics Research
Lori Verstegen Ryan, Ann K. Buchholtz, and Robert W. Kolb
ABSTRACT: Corporate governance and finance are dynamic academic fields that offer
myriad opportunities for business ethics analysis. Within the corporate governance triad in
recent years, shareholders have increased their power over boards of directors and executives
through both regulation and movements to change corporate by-laws. The impact of board
characteristics on firm performance has proven elusive, leading to questions conceming
board processes and individual director beliefs and behaviors. At the same time, CEOs have
lost considerable power, leaving many struggling to regain their control and maintain their
compensation levels, while others adopt a stewardship approach to their posts. In the field
of finance, the recent financial debacle has led to a reexamination of financial regulation and
of the fundamental nature and purpose of the industry. All of these issues provide business
ethicists fodder for investigation and analysis.
O ACADEMIC DISCIPLINES have been more affected by the “Decade from
Hell” (Serwer, 2009) than those of corporate govemance and finance. From the
perspective of these fields, the decade began with the dot-com “bust,” then moved
through the Enron-era scandals and their ensuing legislation and listing mies, to
the drawn-out implementation of compliance with those mies, and then, ultimately,
to the most recent debacle in the govemance of the U.S. financial and automotive
industries. The compilation of these well publicized episodes resulted in a radical
shift both in the public’s awareness of these academic disciplines and in corporate
behavior. Our goal in this paper is to illuminate some of these recent events and
changes in corporate govemance and finance practices that offer research opportunities for business ethics scholars, as well as to assess long-standing issues still
in need of ethical investigation. We will address the fields of corporate govemance
and finance in tum.
Corporate govemance comprises the roles, responsibilities, and balance of power
among executives, directors, and shareholders. After abrief description of the varied
roots of the field, we assess the changing roles and responsibilities of these three
groups and conclude with a brief discussion of their dynamic balance of power.
The academic discipline of corporate govemance draws on three underlying
disciplines: law, management, and finance. The legal discipline—both corporate
law and contract law—is central to the field. Corporate law has set the parameters
©2010 Business Ethics Quarterly 20:4 (October 2010); ISSN 1052-150X pp. 673-694
674 BUSINESS ETHICS QUARTERLY
of corporate governance since the inception of the corporate form (Macey, 2008).
Contract law, on the other hand, involves the enforcement of corporate contracts
between governance constituencies, often working within the framework of a bargain
that would have been reached between shareholders and executives of a firm in a
hypothetical negotiation (dubbed “non-contractual law” by one skeptical leading
researcher [Macey, 2008: 29]).
Many law review articles in the field make careful legal arguments based on
explicit ethical premises, offering a rich resource for the business-ethics researcher
investigating corporate governance. Research ranges from insightful analyses of
more traditional legal topics, including trends in securities regulation (Gerding,
2006) and principle-based vs. rule-based corporate governance law (Anand, 2006),
to examinations of the roles of the media (Borden, 2007) and of hedge funds (Briggs,
2007; Kahan & Rock, 2007) in corporate governance.
The scholarly management literature addresses issues related to all three constituent groups, both theoretically, such as recent articles related to director interlocks
(Shropshire, 2010) and management’s treatment of institutional investors (Westphal
& Bednar, 2008), and empirically, such as studies of the relationship between firm
environmental performance and executive compensation (Berrone & Gomez-Mejia,
2009) and of the impact of CEOs’ advice networks on firm performance (McDonald, Khanna & Westphal, 2008). This literature is also fundamental to the corporate
Finally, the finance discipline, which will be discussed in its own right below, offers
a plethora of primarily empirical resources for the corporate governance researcher.
Topics as varied as the impact of governance mechanisms and investor activism on
firm performance (Brav, Jiang, Partnoy & Thomas, 2008; Cremers & Nair, 2005),
the ethics surrounding the subprime debacle (Jennings, 2008), investor trust in the
market (Guiso, Sapienza & Zingales, 2008), and the effectiveness of “busy” directors
(Fich & Shivdasani, 2006) are all within the purview of finance researchers.
Corporate governance scholars combine, contrast, and test arguments and findings
from these three literatures to focus on the behaviors and nuances of the corporate
As noted above, researchers from all three fields address such ethical issues as
trust, subprime ethics, principles vs. rules, and conflicts of interest, all topics of
interest to business ethics scholars. While traditional questions of the separation
of ownership and control and managerialism remain, the primary entry into these
conversations lies in the dynamism of the field: corporate governance practice is in
constant flux, offering researchers ongoing opportunities to examine and comment
on these new and competing practices. In order to facilitate business ethics scholars’
potential exploration of the field, we now discuss the recent events and research in
corporate governance, examining shareholders, directors, and executives in turn.
Through the early 2000s, institutional investors have waged a multi-stage campaign
to gain greater control over excessive CEO compensation, which many consider to
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 675
be a clear indicator of poor oversight by boards of directors. The campaign began
with the push for majority voting for directors, followed by the say-on-pay movement, and most recently by the demand for the right to nominate directors. All of
these battles offer fodder for ethical investigation.
The first initiative was to move corporate voting from a pluralist model to a majority model (Lesser, Hoffman & Bromfield, 2006), Through most of the twentieth
century, U,S, shareholders received—and seldom returned—proxy ballots that
allowed them to vote “yes” or “withhold” for director candidates. Thus, any director who ran uncontested (which was most) and who received any number of “yes”
votes gained or retained the board seat, even if the vast majority of proxies were
Institutional investors found this system untenable, and in 2004 began campaigning with corporations to change their by-laws to allow for “majority voting” (Lesser
et al,, 2006), While it comes in several forms, majority voting generally consists
of allowing shareholders “yes” or “no” votes, and requires an aspiring director to
eam a majority of “yes” votes of the ballots cast in order to join the board. Many
corporations converted their voting systems voluntarily as they recognized this
impending sea change. Others resisted until investors filed proposals for a formal
shareholder vote, many of which passed. However, such proposals are non-binding
“advisory” votes that simply communicate to management that investors would
“prefer” an amendment to corporate by-laws. In this case, many firms whose investors recommended the by-law change complied. More than 66 percent of S&P 500
firms now have majority-voting mies for uncontested elections (CalPERS, 2009),
an impressively smooth victory for shareholders.
Business ethics researchers could examine both the historical roots and current
demise of the pluralist voting system in the United States, along with the advisability
of and ethical problems inherent in majority voting. Boards who receive these advisory votes have a choice whether or not to remove a given director, and must decide
whether fiduciary duty leads them to cooperate with investors’ stated desires or to do
what they take to be in shareholders’ long-term interests. Shareholders’ reactions to
that decision—including potentially filing a lawsuit—also deserve examination.
Investors next sought to add “say-on-pay” amendments to the by-laws of their
portfolio firms (Blandeburgo, 2009), which would allow them to voice non-binding
votes of support or opposition to a CEO’s compensation package. While some see
executive compensation as well within the proper purview of boards of directors,
others argue that boards have abused that discretion and have been co-opted by
management. Some firms, such as first-mover Afiac (Jones, 2007) and Microsoft
(Investment Weekly News, 2009), adopted the measure voluntarily, while others,
such as Cisco (Modine, 2009), faced shareholder proposals that yielded positive
votes. In the midst of the “say on pay” movement, the financial crisis and ensuing
bailouts led the federal govemment to become involved in executive pay limits and
now legislation on the subject. The House of Representatives passed the Wall Street
Reform and Consumer Protection Act in December 2009, which includes a provision
for shareholders to have an advisory vote on executive compensation (Bay, 2009),
676 BUSINESS ETHICS QUARTERLY
The Senate financial reform bill ultimately passed in May 2010, and continues to
undergo reconciliation in Congress (Dennis, 2010).
Business ethics researchers examining this subject could consider the proper role
of investors in setting CEO pay, which has long fallen under the business judgment
mle, protecting firms from investor interference in day-to-day operations. If boards
have, indeed, been co-opted and are paying CEOs unnecessarily exorbitant salaries,
shareholder involvement may be appropriate. However, the question remains whether
this involvement should be legislated and whether an existing, more macro-level
tool, such as board elections, should be used to solve the problem.
The latest shareholder empowerment action to gain ground is “proxy access,”
which would give investors the right to place competing nominees for director seats
on companies’ official proxies. While this issue has been under discussion since
the early 2000s (Pozen, 2003), it achieved a major milestone when, as of August
1, 2009, Delaware corporations were freed to adopt by-laws that allow shareholder
nomination of directors (McGregor, 2009). Proxy access that would enable onepercent owners to nominate directors was also proposed as an SEC mling as of
July 2009, with the public comment period extended into 2010 (Nathan, Brauer &
Papadima, 2010). Many shareholders believe that the ability to propose their own
slate of directors could reduce the entrenchment of management-co-opted directors. Opponents argue that investors are less capable than nominating committees at
recognizing and fulfilling boards’ personnel needs and that frequent tumover would
reduce a board’s teamwork and its focus on long-term initiatives. Proxy access
has been controversial due to investors’ implied presumption that their knowledge
of which directors are optimal for a given board tmmps current board members’
knowledge and willingness to follow their fiduciary duties. The intentions of both
sides deserve business ethics researchers’ attention.
Aside from this campaign to gain more power over boards, investors have also
focused significant effort on abolishing CEO duality in the U.S., which consists of
CEOs also serving as Chairmen of the Board of their corporations. While empirical evidence conceming the impact of CEO duality on firm performance continues
to be inconclusive (Finegold, Benson & Hecht, 2007), investors have voiced their
preference for the separation model prevalent in other corporate govemance systems.
Many U.S. corporations have responded to this demand not by separating the roles,
but by adding a new role of lead or presiding independent director to take charge
of such duties as the independent directors’ annual executive session, required of
NYSE-listed firms (Monks & Minow, 2008). The benefits of CEO duality remain
unclear, as does the rationale behind U.S. firms’ unwillingness to follow the remainder of the world’s corporate govemance systems in separating the two roles
in non-family controlled firms. Given the lack of empirical support for duality’s
impact on firm performance, investors’ presumptions about the ethical dangers of
CEO duality also deserve examination.
These efforts by traditional institutional investors have been augmented over the
last decade by those of a new activist partner, the hedge fund and private equity
industries. These funds are significantly less regulated than traditional institutional
investors, and hedge funds, in particular, are able to engage in a variety of risky
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 677
investment strategies that gamer exorbitant pay for managing partners (Schneider
& Ryan, forthcoming). Their activism has resulted in radical change in corporate
board rooms in recent years, and has eamed on average a 4-7 percent abnormal
retum on investment for the twenty days surrounding the filing of their 13(d) announcement of intent to intervene (Brav et al., 2008). The high level of risk and lack
of transparency surrounding these funds have led to a public outcry for increased
regulation that concluded in heightened SEC restrictions in recent years, only to be
overtumed by the federal courts due to the funds’ special characteristics (Schneider
& Ryan, forthcoming).
Donaldson (2008) initiated the business-ethics analysis of hedge funds by examining the ethics of increased regulation. Despite regulation advocates’ complaints of
unfair tax benefits, investor “duping,” and “alleged social harm,” Donaldson opposes
greater regulation, concluding that it would reduce fund managers’ entrepreneurial
motivation and be nearly impossible to enforce. Other scholars agree, arguing that
hedge fund and private equity activism are a last bastion of corporate governance
monitoring and control (Macey, 2008). While free-rider problems and heavy regulation hamstring individual and institutional investors, private equity and hedge fund
investors are free to take major positions in underperforming firms and work with
management to improve their corporate govemance and strategic practices.
Private equity firms that engage in highly leveraged buyouts have also come under
recent scmtiny in the business ethics literature. Concemed that these firms focus
excessively on shareholder welfare at the expense of other constituencies, Nielsen
(2008) offers both ways to stop these buyouts and other mechanisms for hampering
them. Clearly, the issues of risk, transparency, faimess, and regulation associated
with hedge funds and private equity firms offer rich and timely opportunities for
further ethical analysis.
Most recently, an even newer form of shareholder has entered the scene in the U.S.
The relationship between govemment and business has shifted, as the federal govemment has become a major shareholder in some firms and has intensified regulatory
pressure on others. This new relationship creates a plethora of potential conflicts
of interest for federal officials, as they simultaneously serve as regulator, pension
guarantor, tax beneficiary, customer, owner, and lender (King, Neil, McCracken &
Spector, 2009). Businesses’ side of the equation also presents an opportunity for
ethical analysis, as General Motors, for example, used millions in TARP monies to
fund both its sixty-day money-back guarantees and its federal lobbying efforts for
concessions in non-TARP arenas (Camey, 2009). Of course, access to such a deep well
of funds is not available to Ford as an independent competitor (Anonymous, 2009).
Many TARP firms have also mshed to repay the loans, perhaps primarily driven by
the govemment’s caps on executive pay, which severely limit the pool of candidates
qualified and willing to lead the troubled companies out of distress (Rothacker, 2009).
Both the govemment’s interventions and the companies’ attitudes toward TARP
expenditures and repayment offer fmitful topics for ethical investigation.
Shareholder power has escalated rapidly over the last two decades with the consolidation of equity holdings into the hands of institutional investors, and 2000s laws
and regulations have raised shareholder control to unprecedented heights. This level
678 BUSINESS ETHICS QUARTERLY
of power in relation to executives and boards of directors, and investors’ proper use
of it, offers a wide variety of avenues for business ethics researchers.
Boards of Directors
For years, corporate govemance research has been dominated by concems with board
stmcture, composition, and vigilance (Finkelstein, Hambrick & Cannella, 2009).
As a result, corporate govemance scholars have tended to focus on such variables
as CEO duality, percentage of outsiders on the board, percentage of stock ownership by directors and CEOs, and board size. These “usual suspects” (Finkelstein &
Mooney, 2003: 101) have not been shown to improve firm performance (Dalton,
Daily, Certo & Roengpitya, 2003; Dalton, Daily, Ellstrand & Johnson, 1998), yet
they appear on “best practices” checklists, and many boards have enacted these
recommended reforms in response to pressure from institutional investors and public
opinion. In 2000, with the stmctural reforms mostly in place. Business Week suggested that, “the govemance battle has largely been won at big companies” (Byme,
2000: 142). One year later the Enron and WorldCom debacles unfolded, followed
by a wave of restatements that demonstrated that boards were not running as tight
a ship as their performance on traditional govemance indicators suggested. Not
only had the govemance items on those checklists never received robust empirical
support (Finegold et al., 2007), but they then also failed to achieve desired results
in practice (Finkelstein & Mooney, 2003). These occurrences brought home the
point that research into boards of directors needs new theoretical perspectives and
new ways of examining what boards actually do.
This failure of stmctural board research underscores an opportunity for business
ethics scholars to add new value to corporate govemance discussions by diving
more deeply into board processes (Ravasi & Zattoni, 2006). Board stmcture and
composition variables have been widely exploited in corporate govemance studies, because these data can be obtained relatively easily from publicly available
corporate proxies. For corporate govemance research to expand in new directions,
however, it will be important for govemance scholars to adopt new approaches
both conceptually and methodologically (Daily, Dalton & Cannella, 2003; Forbes
& Milliken, 1999). This opportunity presents a challenge for scholarship on boards
of directors, because boards are understandably resistant to being observed as they
go about their work, concemed that confidential information may be leaked and
that being observed might affect board processes (Leblanc & Schwartz, 2007).
Surmounting that obstacle will require innovative and even bold research designs,
while deriving necessary insights from such studies will require a broader range of
theoretical perspectives (Daily et al., 2003; Huse & Zattoni, 2008; van Ees, Gabrielsson & Huse, 2009). Researchers should also look beyond the Fortune 500 firms
that have populated the majority of corporate govemance samples. The boards of
smaller firms (Huse & Zattoni, 2008), younger firms (Pollock, Chen, Jackson &
Hambrick, 2010), family firms (Le Breton-Miller & Miller, 2009), and private firms
(Uhlaner, Wright & Huse, 2007) remain understudied in spite of the opportunities
they offer to researchers.
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 679
As new ways of collecting information about boards are developed, new questions
can be asked. The motivations of board members hold normative implications that
merit further study. For example, board member compensation creates a natural
conflict of interest because board members design and set their own compensation
(Dalton & Daily, 2001). Certo, Dalton, Dalton, and Lester (2008) noted that board
pay can lead to ethical dilemmas and subjected their theory to a test. Focusing on
takeovers, they found that board members of the acquiring firms were paid significantly more than those in a control group, and they questioned whether the board
members might have been expanding the firm to increase their own pay instead of
to enhance shareholder wealth. Hillman, Nicholson, and Shropshire (2008) extended
the research on individual board members by examining the extent to which board
members identified with the organization, with being a CEO, with being a board
member, with shareholders, with customers, and with suppliers affected by their
actions. Lack of identification might also provide a window into board member
values. Perhaps the most interesting question regarding board member motivation
is why they want to be board members at all (Hambrick, Werder & Zajac 2008).
Board members receive blame for corporate failure but relatively little credit for
corporate success. They risk attacks from the press and stigmatization when the
company does poorly (Wiesenfeld, Wurthmann & Hambrick, 2008), and they do
so for less than extravagant rewards (Finkelstein et al., 2009). Understanding the
individual motivations and contributions of board members will not only shine a
light on board member processes, but also aid practitioners in both recruitment and
Typically, boards have been viewed at the group level of analysis and individual
differences among members have been outside the scope of the research. This limitation has begun to change, with an increase in attention to board member diversity,
as more women and minority representation on boards makes the examination of
diversity possible. Studies of board diversity can help us to understand the values
of individual board members. For example, Williams (2003) found a relationship
between the proportion of women on the board and the firm’s corporate philanthropy.
In theory, diverse boards should have the range of experiences necessary to understand the needs of diverse constituencies, helping them to guide organizations toward
more effective management (Joo, 2003). Recent research showed that boards tend
to have more women in industries with more women in the customer base (Brammer & Pavelin, 2008) and that the reputational effects of having more women on
the board are felt only in those industries (Brammer, Millington & Pavelin, 2009).
Of course, boards of directors remain relatively homogeneous, so it is difficult to
find opportunities to test the impact of board diversity and to achieve the statistical
power needed to see any impact reflected in empirical findings.
As discussed above, recent events have made the government a major player in
corporate governance, raising a host of questions for scholars to tackle. Researchers have just begun to contribute to these questions. For example, we know that,
in general, having former government officials on boards can benefit the firm
(Hillman, 2005; Hillman & Hitt, 1999). Lester, Hillman, Zardkoohi, and Cannella
(2008) expanded on this work to explore how individual former government official
680 BUSINESS ETHICS QUARTERLY
board members differ. They explored the depth and breadth of the human and social
capital that govemment officials provide as outside directors, as well as the ways
in which it deteriorates over time. Future studies should also explore the impact
of govemment intervention on corporate govemance. One researcher opined that
govemment intervention could “kill corporate govemance” by diminishing boards’
authority and responsibility (Elson, 2009), Business ethics researchers could add
much to this nascent stream.
Executive values and motivation lie at the heart of ethics research in corporate
govemance, as executives’ fiduciary duties to shareholders constitute moral obligations (Easterbrook & Fischel, 1996; Williams & Ryan, 2007), Upholding these
duties requires adherence to a personal ethic that entails consideration of and respect
for others who are not part of the executive’s traditional in-group (Cosans, 2009),
Shareholders become vulnerable when they relinquish control over their assets to
executives, who hold an advantage over them due to information asymmetry (Marcoux, 2003), Executives then sometimes exploit these vulnerabilities by manipulating
information in a way that violates their responsibilities of loyalty, candor, and care
(Williams & Ryan, 2007),
One way that CEOs can exploit CEO/shareholder information asymmetry is to
manipulate stock analysts, on whom shareholders rely for stock purchase decisions.
Stock analysts have been found to be susceptible to impression management. For
example, analyst reviews of charismatic CEOs tend to be both more positive and
more error-ridden (Fanelli, Misangyi & Tosi, 2009), Knowing that analyst reviews
can be manipulated, CEOs have devised ways of appearing to make meaningful
changes in firm govemance without effecting real change in firm practices. Westphal and Graebner (2010) found that CEOs respond to negative analyst appraisals
by appearing to make changes in board independence without actually increasing
board control. They showed that verbal impression management, combined with
fewer board member contractual ties to the firm, resulted in improved subsequent
appraisals even with no real difference in board control, Westphal and Clement
(2008) examined how some CEOs reward positive analyst appraisals with favor
rendering and penalize negative appraisals with negative reciprocity, CEOs can
even use persuasion and ingratiation to deter institutional investors from forcing
changes that would benefit shareholders at the expense of top executives (Westphal
& Bednar, 2008), The marketing of stock to target types of investors has also become
increasingly sophisticated, with specialized personnel, dedicated technology, and
the ability to single out specific shareholder groups, allowing CEOs to help shape
their own firms’ shareholder bases (Williams & Ryan, 2007),
The extent to which top executives pursue self-interest rather than their moral
obligations calls into question the personal ethics of those who hold top executive
posts. However, relatively few studies have explored executive ethics and values
directly. In an effort to move executive values research forward, Hambrick and
Brandon (1988) condensed previous executive values research constmcts into six
DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 681
dimensions: collectivism, rationality, novelty, duty, materialism, and power. Others
have explored national culture as a source of executive values (Elsayed-Elkhouly
& Buda, 1997; Jacoby, Nason & Saguchi, 2005). Direct examinations of the moral
reasoning and values of managers (Posner, 2010; Weber & McGivem, 2010) may
eventually help in the quest to understand executive morality, as could the emerging
field of behavioral ethics (De Cremer, Mayer & Schminke, 2010). The dearth of
research on executive values represents a significant loss to corporate govemance
research and opportunity for researchers, not only because of the direct effect that
values have on executive decision making, but also because of the indirect effect that
personal values can have on executives’ field of vision (Finkelstein et al., 2009).
The personal ethics of top executives leads to the question of the relationship of
the board to the CEO, which can be collaborative, confrontational, or some combination of the two. In assessing the board/CEO relationship, researchers most often
draw from agency theory, with its assumptions of executive shirking and self-interest
maximization (Hambrick et al., 2008). Other research draws from stewardship theory,
with its assumptions of executive good will and firm-interest-maximizing motivation (Davis, Schoorman & Donaldson, 1997). The key difference between the two
views is the personal ethics of a given CEO and the extent to which that CEO can
be trusted to pursue the best interests of shareholders, even when they conflict with
that CEO’s self-interest. The greater the extent to which the CEO has intemalized
firm values, the less extemal control will be needed (Eccles & Wigfield, 2002). Nevertheless, corporate govemance research has typically focused on extrinsic factors,
such as board monitoring and incentives, rather than on CEOs’ intrinsic motivation
(Boivie, Lange, McDonald & Westphal, 2009). Business ethics researchers are well
positioned to examine the understudied intrinsic factors that influence the extent to
which CEOs fulfill their duties to shareholders.
The alignment of incentives is a challenging task, so top executive compensation
is another research area in which many business-ethics questions remain. Much
of the executive compensation research has focused on establishing a connection
between executive pay and firm performance, yet, despite expending considerable
effort, researchers have not been able to show a consistently strong link between them
(Devers, Cannella Jr., Reilly & Yoder, 2007). Moreover, the executive compensation
issue is more complex than simple incentive alignment. Researchers need to consider
issues beyond the determinants of executive compensation and its firm-performance
outcomes and analyze the ethics and effects of executive compensation. One question being raised relates to the size of compensation packages and whether CEOs
face a moral limit on how much compensation they should accept (Moriarty, 2005,
2009). Stock options also pose a host of ethical dilemmas, both for the executives
that receive them (Angel & McCabe, 2008) and for the firms that award them (Kanagaretnam, Lobo & Mohammad, 2009). For example, CEOs have been shown to
be more likely to manipulate eamings when their options are out of the money and
they have lower levels of stock ownership (Zhang, Bartol, Smith, Pfarrer & Khanin,
2008). Similarly, researchers have found an association between stock option repricing and favorable market movements, suggesting opportunism that is made possible
by information asymmetry (Callaghan, Saly & Subramaniam, 2004). In the wake
682 BUSINESS ETHICS QUARTERLY
of option backdating scandals, newer mechanisms, such as restricted stock grants
and option exchanges, also merit ethical analysis (Hamlin, 2009).
Clearly, opportunities for business ethics researchers abound in the corporate
govemance arena from the perspective of all three key players in the corporate
govemance triad. Research is also needed conceming the overarching issue of the
balance of power among the three groups. As discussed above, over the last several
decades, investors have accmed increasing power to affect the govemance of the
firms in their investment portfolios, yet many executives continue to resist their
intervention. With boards of directors at the fulcmm of this dispute, analysis of the
relative rights and responsibilities of the three groups, with a particular focus on
power, could yield invaluable results. We tum now to the more specialized issues
embedded in recent events in the field of finance.
In contrast to the corporate govemance field’s varied sources, finance has unitary
roots as a daughter discipline of economics. Finance traces its independent origins
to the 1950s and particularly to the development of portfolio theory (Markowitz,
1952). The early decades of the finance discipline have been characterized by a
strong conceptual dependence on three notable borrowings from economics: a
narrow conception of rationality, a restricted view of the good as wealth maximization and risk aversion, and a methodological commitment to instmmentalism as
an interpretation of science.’ (Friedman (1966) represents a powerful and widely
influential commitment to this view. For an extended discussion of the issues of
scientific realism and instmmentalism as they pertain to economics and finance, see
Rosenberg (1994).) These three pillars held sway over finance until the 1980s, and,
during the intervening decades, academic finance and the broader finance industry
became increasingly intertwined with this common conceptual framework.
This posture of the finance discipline and industry has left little room for any fmitful interaction between ethics and finance. After all, if rational humans pursue their
own very narrowly conceived interests, the ethical critique of finance is restricted
to being an extemal one, left merely to call into question the ethics of the entire
finance enterprise. For example, with such a narrow specification of rationality, no
conceptual room remains for a discussion of moral psychology as it relates to the
theory or practice of finance.
Since the 1980s, however, these early verities have come under increasing attack
from within the finance discipline. Most notably, the development of behavioral
finance has forced an increasing recognition of the inadequacy of finance’s conception of reality and a broadened understanding of the ends of human life (Kahneman
& Tversky, 1979; Kahneman, Slovic & Tversky, 1982; Thaler, 1993). Stemming
largely from game theory, experimental economics and finance quickly demonstrated
that cooperation dominated the direct pursuit of narrowly conceived self-interest by
using experiments such as the “tit-for-tat” game (Milinski, 1987).
A similar experiment showed that people were quite willing to sacrifice immediate
self-interest to punish perceived unfairness in the “ultimatum game” (Oosterbeek,
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 683
Sloof & van de Kuilen, 2004). In the ultimatum game there are two players. One
player receives a sum of money and is asked to propose a division between the two
players. The second player may accept or refuse the division. If the second player
accepts the division, both parties keep the funds according to the division that was
proposed. However, if the second player refuses the offered division, both players
receive zero. If utility is a function only of wealth, and only utility matters, the best
proposed offer is only a penny, and the “rational economic man” will accept this
increment in wealth even if it means that the other player keeps a huge sum. As a
thought experiment, it is easy to see that very unequal divisions may be rejected by the
second player as being unfair, which would cause the second player to sacrifice wealth
to punish unfaimess. This intuition has been confirmed by hundreds of instances
of this kind of game. The sacrifice of any wealth to punish others is inexplicable if
human utility is solely a function of increasing wealth and avoiding risk.^
Today, for the most part, finance continues to maintain a commitment to viewing
the firm as the property of shareholders and continues to insist that corporations
should be managed for the benefit of those shareholders. As a consequence, the
main impact of behavioral finance is a challenge to the simple utility functions that
emphasize only wealth and risk avoidance, which have dominated the field of finance
since its exception. Even if the financial management of firms aims only to promote
shareholder utility, that utility must now be conceived in terms that embrace more than
wealth maximization and risk aversion. It should be noted, in faimess, that finance
has long perceived that shareholder wealth maximization might not be the same as
shareholder utility maximization for each individual shareholder, but maximizing
wealth was taken to be a reasonable proxy for shareholder utility in general.
This expanded conception of the good for shareholders opens a richer conceptual
space and provides an intellectual foothold that business ethicists may use to engage
more fully with the finance discipline. The remainder of this section suggests several
broad topic areas and recent events related to finance that may offer business ethicists
new opportunities to contribute to an enhanced discussion of ethics in finance.
Within a model of corporate govemance dedicated to maximizing shareholder
utility, a broader understanding of the interests of shareholders may provide a path
to at least a partial rapprochement between the shareholder and stakeholder models
of governance. Shareholders may expect executives and boards to pursue profit
within constraints that include care for communities, the environment, and various
aspects of corporate social responsibility. As the ultimatum game shows, individuals
do sacrifice monetary gain to promote faimess and punish selfishness. Thus, it must
at least be possible that firms could maintain a dedication to promoting shareholder
interests without focusing exclusively on maximizing their wealth. The popularity of
so-called socially responsible investing shows that some investor clienteles are very
interested in corporate goals other than wealth maximization (Harrington, 2003).
One perspective on the finance revolution regarding investor utility functions is that
finance theory now largely grants at least some form of instmmental stakeholder
theory solely as a means to advance the goal of maximizing shareholder value.
From this perspective, the utility of shareholders could embrace the utility of the
community or of other individuals. At the very least, this position may sharpen the
684 BUSINESS ETHICS QUARTERLY
debate, as the real issue is between a focus on shareholder utility (now more broadly
conceived) and the demand that the firm must consider as an intrinsic end the well
being of others, above and beyond their contracted relationships with the firm. In
addition, within a view of shareholder utility maximization that is not merely concerned with wealth maximization and risk avoidance, the ethical question of how
broadly one’s utility function should range is now much more salient. That is, for a
shareholder whose utility is determined to some extent by the well-being of others,
how much weight should such other-regarding concerns receive?
Perhaps one fruitful way of thinking of this problem is to begin with the smallest business, a sole proprietorship with only one employee, such as a single-person
consulting firm. In the battle over the role of the firm, it is seldom alleged that such
small firms have broad obligations of “corporate social responsibility,” and small
firms in general seem to receive a pass in assessments of social obligations. This is
true whether these putative social obligations are conceived in a merely instrumental sense or in a richer one. From an ethical point of view, what is the ground of
this difference in common intuitions about small versus large firms? From a moral
point of view, why should large firms have richer obligations toward those outside
the firm than do small firms? If no legitimate ground for distinction exists, and if a
one-person firm has obligations that go beyond the financial interests of the single
individual involved, then one may well wonder why a mere employee does not
have similar responsibilities. In other words, an adequate account of the social role
of the corporation needs to embrace businesses of all sizes and must offer a single
explanation suitable for firms of all sizes or must offer an explanation of why the
obligations of large firms differ from those of small firms.
Consistent with its historical emphasis on wealth maximization, finance teaches
the evaluation of projects based on maximizing the net present value (NPV) of an
investment and on quantitative cost-benefit analysis. From a normative point of
view, the finance discipline has made a persuasive case that such modes of analysis
maximize societal wealth, so that they are claimed to be morally superior because of
that greater contribution. Yet business ethicists seem offended by such an approach
to investment decision making. For example, the most popular and prevalent narrative of the Pinto fire hazard case generated widespread outrage based on its alleged
monetary valuation of human life through the application of cost-benefit analysis.
This appraisal of the events surrounding the Pinto remain prominent in public consciousness, even though more considered scholarship even denies that Ford actually
decided to apply such analysis (Schwartz, 1991; Lee & Ermann, 1999).
If NPV and cost-benefit analysis are morally offensive as modes of determining
the allocation of investment, however, business ethicists in general have so far made
no (or at least very modest) contributions to explaining how such decisions should
be made from a moral point of view (Zwolinski, 2008). In short, much work could
be done on how one should allocate scarce resources, whether those scare resources
are capital or health care in a national health plan.
Risk management is a growing sub-specialization of finance that has gained
increased salience in the aftermath of the financial crisis of 2007-2010 (Fraser and
Simkins, 2010). Awareness is growing that risk management has a strong norma-
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 685
tive dimension that is perhaps most poignantly encapsulated in the outrage over the
“privatization of profit and the socialization of risk,” Yet this important topic has
received relatively little attention from business ethicists (Kolb, 2010), While risk
management at the societal level is clearly important, significant normative issues
come to the fore even in the more pedestrian micro-level instances of risk management. In many situations, managing risk means transferring risk, and the transfer
can be directed toward those who willingly bear it for compensation, as it explicitly
is in many derivatives markets. Alternatively, risk can be transferred to those who
are unable to avoid it, either through their lack of power or due to their ignorance.
For example, airlines once paid their night crews for their total duty hours, so that
they would be paid when the aircraft was unable to ñy due to mechanical problems
or weather delays. Later, the compensation changed so that the crews were paid
a higher hourly rate but only for “block to block” time—the time from when the
plane pushed back to the time that it arrived at its destination gate. This transferred
the risk of mechanical problems and weather delays to flight crews, much to their
irritation. As risk management becomes an increasingly important and distinct part
of finance, the normative issues involved become more deserving of investigation
by business ethicists.
The financial crisis of 2007-2010 has also focused attention on the finance
industry and brought to the fore the question of whether finance is in some sense
special. Broad federal intervention to support the financial system has been justified on the grounds that the provision of credit and the continued functioning of the
financial system were necessary to sustain all areas of the economy. In opposition,
others decried that the govemment was bailing out Wall Street, claims that tended
to ignore that these bailouts usually involved the total loss of shareholder equity
and that the bailouts actually favored the firms’ creditors. For the business ethicist,
the financial crisis and responses to it raise the question of how the finance industry should be viewed compared to other industries. If finance plays some special
economic role, then might it be subject to special obligations? From the point of
view of social organization, a special role for finance in the economy might also
justify special oversight or regulation. In fact, many would argue that such a view
antedates the financial crisis, as finance has long been one of the most intensively
regulated industries. However, the ethical implications of this (perhaps) special role
of the finance industry and its attendant high level of regulation have not been fully
explored. Finally, if the finance industry is special in an important sense and involves
special obligations, then do managers of financial firms have a different role and
special obligations that do not fall on those who manage firms in other industries?
Compared to many areas of human life, it has seemed to some that finance is
especially arcane and that financial contracting is particularly opaque and subject to
extreme informational asymmetries. This issue has been brought to the fore by the
financial crisis, with its allegations of abuse of homebuyers by the finance industry
through predatory lending, “Predatory lending” is a term subject to an extremely
wide variety of definitions, many of which are polemical in their intent to capture
an extremely wide range of behaviors and phenomena. Perhaps predatory lending
can be usefully defined as “knowingly creating a mortgage that the mortgage bro-
686 BUSINESS ETHICS QUARTERLY
ker and originator know, or should know, is financially injurious to the mortgagor”
(Kolb, 2010, forthcoming).
In addition, the financial debacle has demonstrated the opacity of financial
contracting by the extreme complexity of the securities that were based on home
mortgages, a complexity that even the creators of these instmments did not fully
understand. If financial contracting is highly subject to such extremely severe informational asymmetries, then perhaps these kinds of contracts raise special ethical
problems, or at least raise familiar ethical problems in a heightened manner. This too
may be an area in which business ethicists can make a contribution by addressing
the obligation of the parties to achieve conceptual clarity in the contracting process.
By the same token, there is a danger of ethicists attempting to enforce patemalism
in the contracting process that may mn counter to democratic ideals and individual
freedoms. At a minimum, the area of financial contracting provides an opportunity
for business ethicists to explore general issues of contracting and informational
asymmetry in a context where these issues are particularly salient.
In a perhaps extreme attempt to find a silver lining to a very dark cloud, the financial crisis presents some ethical research opportunities in a particularly intense form.
In many instances in human life, there is a gradation of roles between being free to
pursue one’s interests and having a strict fiduciary duty. Often in finance one party
presents itself merely as a “market maker” trading for one’s own account, thereby
abjuring any responsibility toward another trading party. The business ethicist may
well inquire as to whether any such claim is ever sound, and, if it is, under what
circumstances such a posture is ethical. Even if I announce that I intend to act only
in my own interest in an exchange, is such a position an ethical one? Much more
commonly, relationships of exchange involve at least some tinge of fiduciary duty,
as when an appliance salesman recommends one model over another, or when a
broker recommends a stock.
In the financial crisis, it has been alleged that Goldman Sachs and other investment
banks created complex securities and offered them for sale to their clients, perhaps
even recomtnending them as suitable to those clients (Goldfarb, 2010). Yet, at the
same time, the investment bank was alleged to have taken a short position in those
same instmments, seeking to profit from those securities being overvalued. In defense
of this behavior, it might be argued, perhaps unpersuasively, that the investment bank
was merely hedging its exposure to those instmments, not seeking a speculative
profit, and so was not really abdicating an apparent fiduciary role. Further ethical
analysis of the corporate govemance of these banks is warranted.
As goods and services become more complex, whether those goods are machinery, financial products, or medical procedures, information asymmetry between
purveyors and consumers becomes more extreme and questions of duties of care
become more acute. So the problem is an important and general one. However, finance may provide a useful laboratory for the business ethicist in this regard, as the
gradation of roles from market maker to pure fiduciary is particularly fine-grained.
Furthermore, in finance, documentation attempting to state those roles explicitly
is often available for inspection, as in the case of account-opening documents or
NEW DIRECTIONS IN CORPORATE GOVERNANCE AND FINANCE 687
This brief account of recent changes in the field of finance and a highlighting of
some of the large and outstanding normative issues in the field has attempted to point
the way to some research topics for business ethics scholars. Before the financial
crisis, finance was already a discipline in which the earlier verities had come under
intemal pressure. With the financial crisis, the finance function has come under
increased scmtiny that will surely persist for some time. The intellectual ferment
in finance, coupled with greater societal attention, should mean that there will be
fertile research opportunities and a larger audience for business ethicists engaged
with the normative issues that finance presents,
The fields of corporate govemance and finance are socially important and dynamic,
as evidenced by a decade of tumult and scandal. They offer business ethics researchers the opportunity both to dig deep into long-standing and overarching moral issues
and to delve into new and potentially transitory ones.
As detailed above, the field of corporate governance proffers questions related to
the roles, responsibilities, and balance of power among executives, directors, and
shareholders. In recent decades, shareholders have successfully consolidated their
power into fewer institutional hands and have used it to achieve favorable legislation and SEC regulation. Seeing the handwriting on the wall, some companies have
also capitulated on such issues as say on pay and majority voting. In the wake of
this significant change, the proper role of shareholders—both their rights and their
responsibilities—remains a fascinating avenue for future research.
After more than a decade of studies of boards of directors that fail to conclusively
link stmctural board characteristics to firm performance, perhaps more fruitful
research opportunities lie in the study of board processes and individual director
motivations. Gaining access to the board room has become increasingly important,
as has the need for creative empirical approaches.
Finally, CEOs have had their wings clipped in recent years, and some continue
to stmggle to regain their earlier power, A wide variety of executive issues, such
as those related to compensation, selective communication, and manipulation
through impression management, are rife with ethical undertones. Business-ethics
researchers should continue to dig beneath CEOs’ public personae into the nuances
of executive behavior.
The field of finance also presents an unprecedented opportunity for business
ethicists to explore both classic issues and those uncovered during the recent financial crisis. Enduring issues, such as the meaning of shareholder utility, remain to
be solved, as do those underscored more recently, such as the proper levels of risk
management and disclosure by investment banks.
Business ethics researchers in this potentially fmitful area should consider using
varying approaches in their analyses. Most of the work done at the intersection of
ethics with corporate govemance and finance approaches issues from a consequentialist perspective, perhaps because economists tend to do the same. But fascinating
nonconsequentialist questions are embedded in this area, related to such issues as
688 BUSINESS ETHICS QUARTERLY
property rights, free markets, responsibility, personal freedom, and power. Ethicists
who investigate the field using a principle-based approach may arrive at outcomes
that are both novel and illuminating.
Researchers should also monitor carefully the changing legislative limits within
which corporate govemance is carried out. The Sarbanes-Oxley Act caused a furor
among practitioners and market advocates, and has now been pulled back for small
firms. But in the wake of the financial debacle, federal intervention in corporate
affairs is occurring at an unprecedented rate. No group is better prepared to comment on the finer points of its morality than are business ethics scholars schooled
in corporate govemance or finance.
While corporate govemance and finance topics have been well researched in the
past, they continue to present dynamic issues and valuable opportunities for rewarding ethical analysis. We have outlined both recent events and enduring issues that
would benefit from investigation by business-ethics scholars.
1. The early part of this discussion of finance draws on Robert W. Kolb, “Ethical Implications of
Finance,” in Finance Ethics: Critical Issues in Theory and Practice, ed. John R. Boatright (Hoboken, N.J.:
John Wiley & Sons, Inc., 2010), 23-43. This extremely truncated view of rationality and limited conception
of the good are acknowledged to be unrealistic and were never initially presented as being descriptive of
reality. However, these simplifications were posited as useful methodological fictions and justified according to an instrumentalist understanding of scientific theories. Here the contrast is between instrumentalism
and scientific realism: the view that science undertakes to describe the world as it really is. For the most
ardent exponents of scientific realism, such as Wilfred Sellars, the entities postulated by science constitute
a claimed ontology, such that what is held to be real are the entities countenance by science. The most
important articles by Sellars are “Empiricism and the Philosophy of Mind,” in The Foundations of Science
and the Concepts of Psychoanalysis, Minnesota Studies in the Philosophy of Science, vol. 1, ed. H. Feigl
and M. Scriven (Minneapolis: University of Minnesota Press, 1956); “Philosophy and the Scientific Image
of Man,” in Frontiers of Science and Philosophy, ed. Robert Colodny (Pittsburgh: University of Pittsburgh
Press, 1962); and “Scientific Realism or Irenic Instrumentalism: A Critique of Nagel and Feyerabend on
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Wartofsky (New York: Humanities Press, 1965), 171-204. These are reprinted in Wilfred Sellars, Science,
Perception and Reality (London: Routledge & Kegan Paul Ltd., 1963).
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