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Business Ethics

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Running Head: Business Ethics

Business Ethics



The modern theory of the firm, which is central to finance and corporate law, views the corporation as a of contracts among the various corporate constituencies. Upon this foundation, finance theory and corporate law postulate shareholder wealth as the objective of the firm. Research in business ethics has largely ignored this contracts theory of the firm except to reject the financial-legal model as normatively inadequate. Philosophers generally bring philosophical theories of ethics to bear on problems of business, and they regard the contractual theory of the firm primarily as a subject for criticism using the resources of philosophical ethics. In particular, stakeholder theory, which stresses the importance of all groups that affect or are affected by a firm, has been proposed as a more adequate theory of the firm for studying business ethics.

An important benefit of business ethics research conducted within such a framework would be a narrowing of the gulf between business ethics and the fields of financial economics and corporate law. Business ethics is widely dismissed as irrelevant by researchers in these fields because of its failure to recognize the existing financial and legal structures of the corporation, which are built largely on a contractual foundation. Hence, a common framework could increase the relevance of business ethics research and create a mutually beneficial dialogue.

As a framework for identifying and analyzing many common business ethics problems, the contractual theory focuses our attention on the need to provide adequate safeguards for each constituency's interests. Corporate governance is concerned primarily with protecting shareholder interests, in part because the special contracting problems of shareholders are best met by the residual claims that the law of corporate governance creates. The comparative neglect of other constituencies in corporate law is not a matter of concern as long as their interests are adequately protected in some way. How the interests of each constituency are protected--whether by means of corporate governance structures or other means--is a matter of what works best in practice. Before we can devise means for protecting the interests of each constituency, however, we need some understanding of the particular vulnerabilities of nonshareholder constituencies. How specifically can employees, customers, and other constituencies be wronged such that a remedy ought to be devised? In other words, what are the main ethical problems in business?

The following three-fold classification, which is derived from the literature on the ethical problems of contracting, does not encompass every business ethics problem, and, indeed, the next section lists many kinds of problems that are not related to contractual relations. The classification provides a useful perspective; however, on a great many problems of business, and by viewing them within the context of the contractual theory, appropriate remedies can also be identified.

Wrongful Harms

All constituencies, including shareholders, are vulnerable to loss of one kind or another from the activities of a firm. Many of these losses take the form of negative externalities, such as occupational hazards, consumer injury, discrimination, wrongful discharge, pollution, and plant closings. Shareholders, too, can be harmed by fraud, financial manipulation, and mismanagement that reduce the value of a company's stock. Whether harm is "wrongful" depends, of course, on some standards for the harms that constituencies ought to be protected against, and although developing such standards is difficult, we have many examples in tort law and government regulation. For example, developing a standard for workplace safety consists of deciding which possible harms are "wrongful" such that workers ought to be protected against them.


Imperfect contracting results mainly in allocation problems in which one stakeholder group benefits (rightly or not) at the expense of another. Whether employees or shareholders bear the cost of declining business, for example; or whether manufacturers or consumers bear the cost of product obsolescence and the switchover to new products; or whether private employers or public agencies bear the cost of medical care--these are all allocation problems that result from incompleteness or a lack of specificity or transformations in the contractual relations among various constituencies. Just as wrongful harms depend on some standard of wrongfulness, so misallocations assume some standard of what constitutes a "right" allocation.


Some of the most egregious corporate wrongs involve sudden upheavals in which one constituency enriches itself in violation of settled agreements. Takeovers in which shareholder gains come at great expense to other constituencies constitute a prime example; but other examples include corporate restructurings that result in layoffs and the use of permanent replacement workers to crush union strikes. Such conspicuous instances of greed are often challenged in court, but even legal maneuvers may still be regarded as flagrant violations of implicit contracts or other commonly accepted understandings. Misappropriations are like the allocation problems of imperfect contracting insofar as they arise from a lack of knowledge or foresight, but they are more akin to post-contractual opportunism, which usually results from a lack of monitoring. (Kenneth E. Goodpaster, 2001)


Given this classification of business ethics problems, the task of safeguarding nonshareholder constituencies now becomes a question of the most appropriate and effective remedies for each of these three kinds of threats, as well as a question of the extent to which these remedies can be accommodated within the contractual theory of the firm. Although many remedies are available, they fall into three broad categories.

Tort Remedies

The usual remedy for recovery from wrongful harms is tort law. Many of the examples given above are tortious negative externalities which can be remedied through the courts.

Management Responsibility

Corporate law, including the law on fiduciary duties, defines the legal responsibility of management, especially in the exercise of



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