Business Failure and Corporate Managerial Responsibility

 

by

 

Brian Steverson & Mark Alfino

Department of Philosophy

Gonzaga University

 

March 14, 1997

 

 

Prepared for blind review for inclusion in the Annual Meeting of the Society for Business Ethics

August 7-10, 1997, Boston, MA

 

Business Failure and Corporate Managerial Responsibility 

 

 

When businesses fail, their ability to honor agreements, uphold promises, and act on the higher ideals of their mission statements is often compromised. Following the ethical maxim that Aought implies can,@ business ethicists often grant that our practical obligations have to be understood against the backdrop of the relative scarcity or abundance of the business and social environment. Nothing brings on scarcity more dramatically than the total liquidation of a business=s assets. Bankruptcy protection and reorganization can, and probably should, lead businesses to cut back on some of their obligations. But even if we allow this concession to practical exigency, we can still ask probing questions about how the future possibility of business failure may ground our understanding of the current actual obligations of owners and managers (hereafter, managers) to employees. While the obligations of the bankrupt business may devolve to minimal contractual obligations, an analysis of the responsibility of managers for business failure may tell us something important about the nature of both employment and managerial ethics.

In the popular imagination, many business failures are thought of as misfortunes dealt out by a capricious and impersonal market. Indeed, we often talk of business successes as similarly adventitious, like lottery windfalls. But business analysts have built an entire genre of business writing, what might be called the Apost mortem case study,@ around a belief that most business failures could either be predicted or prevented. While the authoritativeness of this genre is clearly enhanced by hindsight, we can surely make a distinction between business failures which are no oneís fault, in the sense that no reasonable person could have foreseen them, and failures which are the managementís fault, in the sense that a reasonably prudent and informed management could have prevented them. Interestingly enough, there are not many other possibilities. Sure, the occasional business is brought to ruin by the actions of a single employee, and some businesses are ruined by the culpable actions of third parties, but the failure of a business of any significant size is, generally, either no oneís fault or the managementís fault.

With this principle in hand, that the failure of a business is, generally, either no oneís fault or the managementís fault, we argue that the conditions under which businesses fail imply a corporate or group responsibility on the part of management to its employees. This takes us beyond two traditional positions: first, that the obligations between managers and employees are purely contractual; and second, that there is no moral obligation between the two parties, merely a mutual self-interest in the success of the enterprise. Our approach to ascribing managerial responsibility is novel because it is based on a theory of collective liability and corporate vicarious agency. Traditional approaches to employer-employee obligations are based on: 1) contract theory, the terms of the employment contract; 2) agency theory, the managerís agency relationship to a principle, such as an owner or stockholder; or, 3) stakeholder theory, the idea that employees deserve consideration by virtue of the fact that they can be affected by organizational decision making. By basing our argument on a liability theory of corporate agency, we avoid some of the limitations of contract and agency theories. As we will show, a corporate liability theory provides a better foundation for stakeholder theory.

Why should we think of a businessís management team as collectively responsible for that businessís failure in cases in which someone is to blame? Donít businesses fail for many reasons which are not the fault of the management? Employees might not maintain their skills, financial conditions may delay reinvestment in capital assets, and markets may change demand for the businessís product. The problem with most excuses for business failure that shift blame away from managers is that they require us to believe that a management team is incapable of anticipating changes in labor, capital, financial, and market conditions, or somehow not responsible for trying. The fact that business failures often affect only one or two businesses among a group of competing businesses belies this way of thinking. Of course, some management teams might just be making lucky guesses to keep their businesses profitable, however, post mortem case studies give plausible explanations for thinking that when business failures are anyoneís fault at all, they are the managersí fault.

Identifying business failure with managerial fault does not by itself show that managers bear a collective vicarious liability for business failure, nor that they are liable to employees rather than owners for their faulty management. In his work on collective responsibility, Larry May identifies two conditions for ascribing collective responsibility to an organization for the conduct of one or more of its members. Corporate vicarious negligence requires both a causal factor and a fault factor. As May explains:

    1. causal factor - the member of the corporation was enabled or facilitated in his or her harmful conduct by the general grant of authority given to him or her by corporate decision.
    2. fault factor - appropriate members of the corporation failed to take preventative measures to thwart the potential harm . . . even though: 1.) . . .[they] could have taken such precautions, and 2.) . . . [they] could reasonably have predicted that the harm would occur. (May 1983, 321)

Those familiar with May=s theory may wonder if it is not misapplied in this case. First, discussions of group responsibility are usually about determining the conditions under which the group is responsible to a third party for the actions of one of its members (e.g., Is a university collectively responsible for the sexual harassment of a student by a professor?). But in this case, we are using the theory to ascribe a collective responsibility of one group within an organization to another group in the same organization. Second, one might wonder why managers are the appropriate group to focus on. Just as no one employee can usually sink a business, so also no one manager can. If managerís are collectively liable to employees for business failure, than employees are no less collectively liable to managers. The responsibilities are mutual and symmetrical. But if we look further into Mayís theory we will see what is wrong with this view.

The theoretical basis for ascribing collective vicarious agency to a whole corporation is the "causal nexus between stockholders or board members and supervisors or employees" (May, 1983, 319). It is true that May does not differentiate between the conditions which make a corporation collectively responsible for its managerís conduct and the conditions which make it responsible for its employeesí conduct. It can be responsible for both. But a crucial feature of May's theory is that collective responsibility is not a product of the unique decision making structure of the corporation, nor of the legal status of the corporation, but merely of the causal connections that allow for coordinated action. In The Morality of Groups, May shows how these conditions can be present in such "unofficial" social groups as mobs (May 1987).

The second objection, that if there is a collective liability between managers and employees, it is symmetrical, is only credible if one ignores the asymmetry in the "grant of authority" which enhances each groupís ability to harm the other. Managerial teams have a unique ability to study and direct the activity of non-managerial employees for the purpose of maintaining the profitability of the organization. They are almost always in a better position to satisfy the "fault factor" necessary for vicarious negligence. On the other hand, there may be situations in which a specific group of employees could be held collectively vicariously negligent, since Mayís theory does not ascribe group responsibility solely on the basis of the formal assignment of duties (May 1983, 320).

Two immediate consequences for management ethics follow from this argument: First, the professional responsibilities of managers can no longer be seen as following exclusively from the agency relationship that they have to owners. While the authority that comes with being someoneís agent is a necessary condition for their responsibility to business owners, it is also part of the basis for making them liable to the employees they manage. Second, organizations which hold to traditional organizational structures which sharply separate managerial and non-managerial work have a heightened liability to their non-managerial employees for business failure. In the organization which devolves managerial responsibility to most of its workers, the collective responsibility for failure falls more squarely with the entire corporate workforce.

Mayís view is not just a helpful theoretical perspective for rethinking management theory, but also a practical framework for thinking about corporate culpability. Since the Federal Sentencing Guidelines for Organizations became law in 1991, the notion of corporate culpability has had a role in determining corporate liability, and, consequently, corporate punishment. The Guidelines refer to the "culpability of the organization" along with "the seriousness of the crime@ as determining factors in setting the appropriate fine range for organizations committing remediable harm, but which are not Aoperated primarily for a criminal purpose or primarily be criminal means, and then go on to list criteria by which to assess an organizationís "culpability score" and its impact in determining the appropriate fine range. The Guidelines reflect, though not perfectly or explicitly, a recognition that organizations such as corporations can develop what Jennifer Moore calls a "corporate character" embodying the "goals, rules, policies, and procedures" of the corporation which in turn shape the behavior of its agents (Moore 1992).

For our purposes, the importance of the Guidelines is that they are a legal recognition of punishable corporate responsibility to groups or individuals within and outside of itself, and, even more importantly, a recognition that the primary component of such culpability is the causal role that organizations play in shaping the behavior of their agents. Our focus is on another such causal relationship, that which exists between managerial decisions and a corporationís success or failure, as providing grounds for assigning organizational responsibility to managers for the harm caused stakeholders as the result of corporate or business failures. The two are connected in that management can be held culpable for the decisions and actions of its members (the causal factor for vicarious agency), and one of the things that its members can be held uniquely causally accountable for is the success or failure of the business. Our approach differs from traditional stakeholder theory, which typically accounts for the obligations that managers have to stakeholder groups in contractarian terms (e.g., employees expect managers to look after their welfare in exchange for their labor and loyalty). Our contention is that the responsibility managers incur for the harm caused by business failure is not due to a violation of some contractual agreement, hypothetical or real, nor is it a consequence of their formal agency relationship to owners or stockholders. Rather, it is due specifically to the unique, collective, and causal role they play in business failure or success. Accordingly, an unique dependency exists between the fate of stakeholder groups like employees and management, sufficiently strong to ground a custodial obligation to employees.

This way of accounting for the stakeholder obligations existing between management and workers more adequately captures the sense in which it is a stakeholder obligation than traditional stakeholder theory. Traditionally, at least in academic business ethics, stakeholders in organizations have been defined as groups or individuals who can affect or be affected by organizational decisions and behavior (Freeman E. & Reed, D. 1983). Goodpaster has used the metaphor of a player in a game of poker to capture the sense that a stakeholder is "one who plays and puts some economic value at risk" via their interaction with organizations like corporations (Goodpaster 1991). Freeman and Reed have distinguished between a "narrow definition" of stakeholders, which includes those groups who are vital to the survival and success of an organization, and a "wide definition," which includes any groups who can affect or be affected by an organization. Now, strictly speaking, the "narrow definition" really does not capture the sense of "stakeholder" which is requisite for grounding organizational obligations to stakeholder groups. The fact that an organization is vitally dependent upon some group or individual for its success and survival does not, by itself, mean that such groups or individuals have any stake in the success or survival of the organization. For example, it is obviously true that individual productive organizations are dependent upon consumers for their success and survival, but consumers do not, thereby, have any stake in whether that particular productive organization survives or not. In an adequate market, where there are other firms producing similar and equally desirable goods, the survival or success of any particular productive organization is not something consumers necessarily have a stake in, especially not in Goodpaster=s sense of having some economic value at risk. Likewise, in certain job markets (e.g., professional sports), the success of a business organization may hinge upon the presence and performance of specific employees, yet their livelihood and continued well-being may not be staked to the success of that particular organization since equally satisfactory work may be readily available elsewhere. The "wide definition" fares better, in that it includes the criterion "be affected by," which reflects the proper dependence relationship for stakeholder status, but the inclusion of the "can affect" ought to be dropped for the same reason that the "narrow definition" inadequate (i.e., wrong dependence relationship).

Furthermore, simply having a stake in the outcome of some group or organizational decision making does not entail that those involved in such decision making have any obligations to other stakeholders who may be affected negatively or positively by the decisions made. For example, consider Goodpasterís analogy. Each player has an economic stake in the outcome of each hand, but none of the players has any obligations to one another to act in their best interest. Each player rightfully acts in their own best interest, as long as the rules of the game are obeyed. In fact, the object of poker is to intentionally defeat the interests of the other players. One of the features of this kind of stakeholder activity is that each player has extensive control over their stake in the game. The better the player one is the more such control one has. Each player has (or ought to have) an understanding of the risks involved in the game, and can act so as to minimize them, and, at the same time, enhance their chances of being successful. Of course, each stakeholder is dependent on the decisions of every other stakeholder involved in the game, but that dependency is minimized by the fact that each player can anticipate and react to the decisions of others, again, so as to protect their own chance at successfully continuing in the game. Consequently, even though a poker player has an economic value at risk, that risk is self-manageable, and other players have no obligations to assist fellow players in avoiding the harm that can result from participation.

It is this "control" factor which, if it is reasonable to assume that business failure is either no oneís fault or managementís fault, is generally missing from the stakeholder relation between employees and the organizations they work for. Unlike in the game of poker, as stakeholders, employees lack the requisite power to manage the risk associated with possible business failure. They are, for the most part, entirely dependent on the decisions and actions of management for the continuation of their employment. It is this unique kind of asymmetric dependency which generates the vulnerability that characterizes the employee-management relation, and which most adequately describes the kind of stake that employees have in the continued success and survival of the organizations they are a part of. Unlike a traditional contractarian accounting of the stake that employees have in organizations which describes that stake in terms of an expected exchange between management and employees (labor and loyalty in exchange for compensation and fair treatment), this way of looking at the nature of the sake employees have in organizational decision making reveals that the ground of the obligation management has to look after the welfare of their employees is not the fulfillment of some real or hypothetical exchange agreement, but, rather, in the fact that management singularly holds the power and responsibility for the success and survival of business organizations, which itself represents the "pot" that employees hope to gain a share of. Put another way, if one were to make use of the "Kews Gardens Principles," namely "need, proximity, capability, and last resort," developed by Simon et al to account for the minimum corporate responsibility of avoiding social harm, one can quite clearly see that in the case of business failure and the harm it causes stakeholders like employees, that all four conditions are readily met, with special emphasis on the fact that management represents the "last" and "only" resort for employees to turn to for help (Simon, J., Powers, C. & Gunneman, J. 1972).

By viewing the collective responsibility of management for the harm caused employees by business failure in this way, one can argue that management incurs a collective obligation to the employees of a business organization to manage that business successfully. Now, this may sound odd since we are accustomed to thinking that any duties management may have to run a business successfully they would have only to the owners or shareholders of the business and would have them because of a fiduciary relationship. Management might have varying obligations to employees for a number of reasons, but surely the obligation to be "good managers" wouldnít be one of them. Our account of the unique collective, causal role that managers occupy in relation to business success or failure and the resulting dependency that employees have on managerial decision making, is intended to show that one can legitimately and meaningfully extend such a mangerial obligation to employees.

 

 

 

 

References

 

Freeman, E. & Reed, D. (1983). Stockholders and Stakeholders: A New Perspective on Corporate Governance. in C. Huizinga, (ed.), Corporate Governance: A Definitive Exploration of the Issues. Los Angeles, CA: UCLA Extension Press.

 

Goodpaster, K. (1991). Business Ethics & Stakeholder Analysis. Business Ethics Quarterly, 1, 53-73.

 

May, L. (1987). The Morality of Groups . Notre Dame, Indiana: University of Notre Dame.

 

May, L. (1991). Vicarious Agency and Corporate Responsibility. in P. French (ed.), The Spectrum of Responsibility, (pp. 313-324). New York: St. Martin's Press.

 

Moore, J. (1992). Corporate Culpability under the Federal Sentencing Guidelines. Arizona Law Review 34.

 

Simon, J., Powers, C., & Gunneman, J. (1972). The Responsibilities of corporations and Their Owners. in the Ethical Investor: Universities and Corporate Responsibility, New Haven: Yale University Press.