Chapter 4

The economic perspective

When presenting the economic perspective in the introductory chapter, two points were raised: one was whether the economic model of capitalism promotes moral behavior or not. This has been covered. The other aspect was how moral behavior impacts a leader’s environment – which for a business leader is the markets. This raises the question of whether the way in which markets work generates a regime or regimes for moral behavior. This brings the essence of the market economy system to human centered management theory. The market-based approaches to business ethics will be dealt with in the following section, and from there the reverse issue will be examined, that is, the impact that moral behavior can generate in the “market.” After this, section 4.2 will show impacts that go beyond the direct environment surrounding a business.

4.1 Market-based approaches to business ethics

4.1.1 Instrumental ethics

Building market-based approaches for human centered management has its first approximation through instrumental ethics, whereby managers choose a corporate social responsibility approach that will also lead to shareholder wealth. Quinn and Jones (1995) argue that this is the one approach to ethics that really makes sense in a world where businesses are confronted with an extant legal and regulatory environment. No big corporation, or any large institutional or small-scale investor, would endorse corporate social responsibility if did not enhance return on investment. Corporate leaders and business owners of all kinds are responsible for legal compliance and the liability of individuals, but beyond that they have to be committed to their firms’ impact on society and the natural environment; they need to feel accountable. And indeed, they are accountable. But they will also expect reward?

With regard to expectations of reward, Homann (2006a) and Boatright (1999) agree that people will adhere more to ethical principles if ethical behavior is recompensed and unethical behavior is punished. Accountability, thus, ranges over compliance, as per the statement by C. K. Prahalad mentioned in section 3.1.2. In the words of Carly Fiorina, when she was chairman and CEO of Hewlett-Packard:

4.1.2 An investment in social cooperation for mutual advantage

A second market-based approach comes from the viewpoint that corporate social responsibility, when governed by ethical leadership, is an investment for mutual advantage (Lin Hi 2008). This investment primarily becomes manifest in building knowledge and stakeholder relations that affect corporate performance (and advantage for the firm), for which a proof can be found in the survey exhibited in section 4.1.5. Needless to say, the firm’s stakeholders gain an advantage from this investment as well, otherwise they would not do business with the firm. The wider subject of relating ethics-based stakeholder relations to corporate performance will take the issue of ethical leadership beyond the boundaries of the firm. One good example is supply chains, where trust and reciprocity are of the highest importance (Capó-Vicedo, Mula, and Capo 2011).

4.1.3 The capabilities approach

A third approach examines the interactions between individuals and between individuals and their organizations, which encompass intangible as well as tangible components. The intangible elements include the mechanisms of the SECI model developed by Nonaka and Takeuchi (1995). SECI stands for socialization, externalization, combination and internalization of knowledge. For this to become effective in the context of people-to-people relations, the notion of capabilities must be added. The nexus with human centered management lies in a perspective that derives from the approach used by Amartya Sen to denote human development. Sen (1985) enumerates five components to assess capability:

• Freedoms in the assessment of an individual’s capability-advantage
• Individual differences in the ability to transform resources into valuable activities
• The multivariate nature of transformations
• A balance of materialistic and non-materialistic factors
• Concern for the distribution of opportunities.

In studying the effect of human centered management on corporate performance, we may conceive of the five components as showing the way from moral attitudes (respecting the differences in the advantages of individuals and in their ability to make use of these advantages, the multivariety and the combination of materialistic and non-materialistic rewards and the concern for widely diverse chances) to effective governance of knowledge. These attitudes per se contribute to an optimal effort (with optimal outputs) through an optimal combination of human talent.

The capabilities approach, with its focus on the drivers behind the formation, evolution and recombination of resources for generating value-creating strategies, identifies interaction between business and society. Social and ethical resources and capabilities can be a source of competitive advantage, such as the processes of moral decision-making, perception, deliberation and responsiveness to the need for adaptation and, naturally, the development of proper relationships with the primary stakeholders: employees, customers, suppliers and communities (Garriga and Melé 2004).

Transforming these resources into business activities will have the double effect of building a moral corporation and positioning the firm in a highly competitive state (Chiappero-Martinetti et al. 2015). There is an intermediate step, though, between identifying the resources and transforming them into strategies or activities, and this is knowledge formation. What we are concerned with here is knowledge about ethical capabilities. Leaders who manage this type of knowledge responsibly will have a lasting impact on their business and on their business environment. This impact, one would assume, is the fundamental outcome of human centered management. To verify this assumption through empirical proof, the next section presents a survey that attempts to measure this outcome.

4.1.4 Moral behavior and business processes: impacts on corporate performance and stakeholder relations

The (direct) effect of corporate social responsibility and business ethics on business performance has been researched through several approaches, one of which, the stakeholder relation approach, was presented in section 2.4.2. Apart from measuring the effect on profitability, analyses also explore the impacts on share value (e.g., Solomon 2007; Jo and Harjoto 2011) and on reputation (e.g., Siltaoja 2006). Rather than repeat exercises like those here, we will look at the results of a survey that show how businesspersons feel about integrating ethics into the processes determining firm performance. A practitioner would say: “Corporate social responsibility is smart business when fully integrated into business processes” (Kyte 2007). This also goes for business ethics. Integration into business processes would imply that principles of ethics permeate everyday decisions and that the social impact of business activities is routinely taken into consideration. The author of this book conducted a survey on this with the participants of an executive education course in Switzerland (Bardy 2015), and the main features of the survey will be reproduced in section 4.1.5. The results reflect some implications for practice, and apposite recommendations will be discussed.

The survey set out from the question of whether business ethics connect to business processes and to stakeholder relations and how intellectual capital and knowledge on ethical principles are built and managed in a firm. There should be impacts of all these on corporate performance. Both in theory and in practice, the constructs of business ethics and corporate social responsibility conjoin with the perspectives of business processes and business performance. In this reasoning, an ethical approach to business is likely to encourage open communication, problem solving, knowledge sharing and creativity among employees (the organizational capital); enhance interactions and relationships with suppliers, customers and other stakeholders (the relational capital); and retain talent (the human capital). These intangible resources are core assets a business can utilize for competitive advantage. The other resource derives from the perspective that corporate social responsibility, governed by business ethics, is an investment for mutual advantage, as said earlier. This investment primarily becomes manifest in building knowledge and stakeholder relations that affect corporate performance (advantage for the firm), as this study will show. Needless to say, the firm’s stakeholders gain an advantage from this investment as well – or they would not do business with the firm.

Another input into the survey was the issue of how knowledge on ethics transcends into business behavior and business processes. The knowledge built up from business ethics can help to improve ethical decision-making by providing managers with the appropriate knowledge and tools that enable them to correctly identify, diagnose and analyze ethical problems and dilemmas. This type of knowledge will provide solutions to those problems and dilemmas, and it will also help to assess the benefits and shortcomings of corporate decision-making in any area of the firm. But any other type of knowledge, about a firm’s organization and employees, its products, customers and suppliers, or its technologies, can benefit from business ethics as well. Morally enhanced attitudes in dealing with knowledge will increase both the validity of business decisions and of its consequences. An even greater effect is on creating, upgrading and disseminating knowledge, which are the intangible components of knowledge management (with storage and documentation being technological or tangible elements, i.e., the means for accessing knowledge content; see Alavi and Denford 2011, p. 107). Undocumented (“tacit”) knowledge and its transfer are even more influenced by a corporate culture based on ethical attitudes such as openness, transparency and mutual consideration. A formal demonstration of this would be where a firm’s knowledge management is governed by the principle of “need to withhold” rather than “need to know” (Guo 2011).

An ethical concept of how to deal with knowledge needs to depart from defining knowledge as justified true belief (Goldman 1979) and knowledge creation as the “dynamic human process of justifying personal beliefs as part of an aspiration for the truth” (Nonaka 1994, p. 15). This way of creating knowledge would also create a business climate that is best characterized by the term open book management, which will be presented in Chapter 7 where implementation issues are discussed.

The ethical concept of knowledge management transforms into a practical panorama through five fundamental effects (McElroy 2003):

1. 1 Overcoming tacitness and complexity within and between corporations: individuals must be guided in their various roles to fundamentally rethink their work patterns, relationships and cognitive frameworks.
2. 2 Extending enterprise and networks: be they “knowledge communities,” “knowledge chains,” “knowledge suppliers” or “knowledge markets” (Gilsing 2006), the foremost requirement is that their participants interact free from affectation or disguise; without this, all modern networking techniques will not produce the desired outcomes.
3. 3 Practicing a “learning organization” (Senge 1994): each person dealing with others must command personal mastery, mental models, shared vision, team learning and systems thinking.
4. 4 Working with multifaceted and parallel approaches (“ambidextrous learning”; Kang and Snell 2009): progress can be achieved only by simultaneously exploring new knowledge domains while exploiting current ones (Kang and Snell 2009).
5. 5 Maintaining continuous connectivity and communication: beyond state-of the art technology, a methodical approach is required for updates, feedbacks, inclusion in surveys and so forth.

All five aspects delineate essentials of business ethics and will level up human capabilities in a firm and its organizational structure. It will thus alter a firm’s intellectual capital, of which human capital and structural capital are the two major categories, with relational capital as a third category of its own (see, e.g., Sullivan 2000, Firer and Williams 2003). Structural capital has been divided into the two subcategories of organizational capital and customer capital (Edvinsson and Malone 1997; Bontis 1998); however, this latter composition is mainly applied to serve the purpose of attempting a valuation of intellectual capital (Ariely 2005). When using a categorization that places relational capital at the side of structural and human capital, we get closer to corporate strategizing: the role of all stakeholders is taken into account explicitly (beyond just “customer capital”), and when corporations earnestly consider stakeholder interests, we arrive at a view on stakeholder relations that has been called a synthesis of ethics and economics (Jones 1995). This instrumental approach, rather than a descriptive or a normative approach, is based on the connections between stakeholder management and the achievement of corporate goals, most commonly profitability and efficiency goals but ethical goals as well (Donaldson and Preston 1995). The argument is for stakeholder management to be both a means to an end, contingent on the value of stakeholder relationships to corporate success, and a means to deploy instrumental ethics as an addendum to the rule of creating wealth. This makes ethics a business case: managers perceive that “good ethics” is “good business” and that employing ethics in stakeholder relations increases firm value (Solomon 2007; Quinn and Jones 1995).

Making the participants aware of the issues and interrelations laid out in the preceding paragraphs was one fundamental step before conducting the survey. The other was a model that depicts the interaction between ethical/moral reasoning and outcomes of business activities.

4.1.5 The ingredients of ethics-led corporate performance: a model of interaction

The model that was presented for the participants of the survey had been solely conceived for surveying the views of high-level managers attending the executive education course. It may be valid in a European and perhaps in a North American context, but not in others. Another disclaimer would be that the proof of the model’s validity may have been influenced by the setting of the survey: it was performed in a course on ethical leadership, and this certainly influenced the answers to the questionnaire.

The model endeavors to measure the effect of human centered management in a firm by gauging the impact of a code of ethics on business processes and stakeholder relations.

Before portraying the model, a few remarks must be made on ethics codes in business enterprises (a general representation of the ethics code concept will be given in section 6.2 of this book). A code of business ethics has to work in conjunction with a firm’s mission statement and with more specific policy documents that govern conduct towards customers, suppliers, research partners and other parties affected by the firm’s activities. Because it represents the essence of corporate culture, there are various steps to be taken when setting up a code of ethics, such as involving employees at all levels, and pointing to real ethical dilemmas that affect the business such as bribery, suppliers that use child labor and so forth. It can be valuable to consult a lawyer when drafting a code of ethics in order to determine what can be construed as legal or illegal and what can be argued in court (Ferrell and Fraedrich 2014). Writing the code should be entrusted to professionals, who can be found in the consulting business or in non-profit institutions (Webley 2003). A decision where consultants cannot really help is about who will be in charge of applying and updating the code of ethics and of monitoring compliance.

A code of ethics needs control of compliance. The size and type of business may suggest that a compliance officer should be appointed. Whoever is put in charge needs to have a strong commitment to the company’s success and good people skills. Quite often the duties of this office are only or mainly directed towards detecting and preventing misuse. A recent “State of Compliance Survey” from PricewaterhouseCoopers gives an extensive list of the risks perceived in the industry and of structural/procedural features; no mention is made of the positive effects that are achieved when compliance (and ethical behavior) is observed (PwC 2014). There is only limited research and very few reports of practical experience on this positive agenda (Treviño and Nelson 2011). One outstanding exception is a report by the Conference Board of Canada (Ezekiel 2006), which demonstrates strong correlations between ethical practices and an assortment of positive outcomes, and it deplores that there is a gap between that type of disclosure and the many findings on unethical behavior. There is some proof of the effect ethical practices in a firm (and, thus, ethics codes) have on corporate performance.

With a code of ethics being one ingredient to corporate performance, the model that is shown here has four ingredients in total:

1. (1) A code of ethics that serves to guide employees’, managers’ and executives’ behavior, (2) conscientious management of stakeholder relations, (3) knowledge management procedures that are enhanced by the respective statements in the code of ethics, and (4) business processes that are conducted along the same lines. The four interact with each other and with corporate performance.

The term corporate performance is not defined in the model – it represents financial performance or market share or share-value. This ambiguity allows a flexible application, above all, when used for a qualitative investigation. For the code of ethics, the model assumes that following the statements of an ethics code improves business process performance and stakeholder relations as well as knowledge management, and also affects overall corporate performance directly.

Exhibit 4.1 Direct and indirect effects of ethics principles on corporate performance

Source: Author

From there, the first four questions were drawn:

• Q1: How do code of ethics statements affect business process performance?
• Q2: How do code of ethics statements affect stakeholder relations?
• Q3: Is there a relationship between code of ethics and knowledge management?
• Q4: How do code of ethics statements affect overall corporate performance?

Likewise, it is assumed that ethically enhanced knowledge management procedures improve business process performance and also have a direct effect on overall corporate performance.

This produces three more questions:

• Q5: How does (ethically enhanced) knowledge management affect business process performance?
• Q6.1: How does (ethically enhanced) knowledge management affect overall corporate performance?
• Q6.2: How does (ethically enhanced) knowledge management affect stakeholder relations?

It is also assumed that conscientious stakeholder management has an effect on business processes and that, vice versa, ethically enhanced business processes affect stakeholder relations. Similarly, conscientious stakeholder management has a direct effect on corporate performance.

The corresponding questions are:

• Q7: How do (ethically enhanced) stakeholder relations affect business process performance (Q7.1)? Is there a reverse effect as well (Q7.2)?
• Q8: How do (ethically enhanced) stakeholder relations affect overall corporate performance?

An unmediated effect is assumed for business processes: if they are conducted in alignment with corporate ethical standards, corporate performance is affected directly:

• Q9: How do (ethically enhanced) business processes affect overall corporate performance?

The questions were submitted to several groups of executives attending an ethical leadership course in Switzerland by way of a questionnaire they received at the end of the course. The survey followed a self-assessment approach based on a scale of 1 to 5, where respondents were asked to assess their opinion about the effects of the ethics code in their firms (all respondents’ firms have a written ethics code) on their knowledge management procedures, on their stakeholder management and on their business processes.

The main result of the survey is reproduced in Tables 4.1 and 4.2. Quantitative statistics are not given here – for a detailed discussion of the results, see Bardy (2015). But the tables delineate quite distinctly where ethical leadership can lead with regard to process performance, overall performance and stakeholder relations.

In summarizing the results with regard to business processes, the survey reveals that there are effects in terms of higher transparency, of less friction at process interfaces, of increased speed of business processes, of improved output quality and of less costly processes and in terms of increased process re-engineering efforts. As far as stakeholder relations are concerned, the study found effects in terms of more dialogues with stakeholder groups, of stakeholder groups reporting more issues of affectedness and effects in terms of more social networks connecting with the corporation. Combining processes and stakeholder relations, there are effects in terms of customer and supplier management processes becoming more transparent and effects in terms of supplier management processes becoming more transparent as well as effects in terms of industrial relationship processes becoming more flexible. The use of this can be threefold: (1) for the theoretical discussion, (2) for the teaching of business ethics and (3) for practical consequences within corporations.

The model, as said, has limitations. The validity may hold true in a European and perhaps in a North American context only. A wider and more diverse sample should be sought for further validation. Another question is whether an ethics code for a corporation headquartered in one country can encompass the sets of values and ethical principles that prevail in other countries. Codes for multinational companies must reflect and accommodate other cultural models, for example, in markets such as Africa and Asia. But a written code of ethics should serve as an expectation and guideline for employee conduct, wherever a business is located. And for a code of ethics to mean anything anywhere, a company has to be willing to enforce it. This usually requires an example of someone being disciplined or the employment contract being terminated for a breach of ethics. However, this sharp consequence will not be upheld where cultural traditions require a softer treatment of the individual, and the same would go for the positive results that a firm expects from “conduct according to code.” Will openness always be reciprocated? Will tolerance of errors always produce betterment? Will strict execution of non-bribery clauses motivate a salesperson to seek other means to acquire orders? These are the caveats that have to be included when looking at a model that seems to fit Western tradition.

4.2 Impacting the wider environment of markets and society

4.2.1 Spillover effects of responsible business leadership

Spillover effects from one business to another or from corporate activity to other sectors of society may occur in multiple ways. Introducing new technologies such as new production processes and techniques, managerial skills, ideas and new varieties of goods and services will not only impact the immediate environment of a firm but the wider social milieu as well. In order for this to occur, a certain “absorption capacity” is required, like a threshold level of human capacity. This may not always be the case within the environment of a firm, for example, when a foreign firm operates in a host country. But foreign investment per se has significant effects that might raise this threshold, and the prudent strategies of an investor collaborating with foreign stakeholders may contribute to establishing the social structures required for this threshold level. This becomes obvious when considering that one basic spillover effect is education.

Although it is commonly assumed that education is provided solely in schools, a lot of education takes place outside formal institutions and through family influence and peer group pressure within the local community. Buckley (2009) states that to benefit from formal education it may be necessary for people to “unlearn” beliefs from their informal education. Thus, unlearning beliefs is one step in changing the order of thought. One example is the economic and institutional progress in some African countries such as Rwanda and Sierra Leone (Foster and Briceño-Garmendia 2009), where improvements could mainly be achieved because people developed a positive attitude towards participation in social and business life. One source of influence was human centered management in government and business (Coulter 2015).

The combined effect of spillovers from foreign aid and investment and transfer of knowledge or technology into a host country can reach as far as moving its status to improved living standards shown in Exhibit 4.2.

The exhibit identifies Status 1 of the society where the main societal actors – business, administrative institutions and civil society – are not closely intertwined. If new business activities enter from abroad (e.g., Object 1) producing technology transfer and knowledge transfer to the investor’s business partners and, by way of spillovers, to civil society as a whole, education and professionalization will improve and enlarge not only the human capital base in the host country but also the opportunities for a new kind of interaction between the recipient of the investment, the employees, and the community as a whole, with effects on living standards and on ethical judgment (Status 2). Subsequent investments (Object 2) will be better accepted and more densely integrated.

Exhibit 4.2 Spillovers from business activities to social order

Source: Bardy (2016)

There are several real-life cases that support the optimistic interpretation of spillover effects, such as the Chad-Cameroon Oil Project, which some call a new model for oil-led poverty reduction (see Gary and Karl 2003). Here, government, investors and community leaders cooperated from the start, and the local communities gradually become stakeholders of the project, with multiple spillover effects on the social order. Social order is a comprehensive public good, and morality is one of its solid building blocks.

4.2.2 The public good of morality

From the civil societies in ancient Greece, which dwelled in well-developed urban settings, from medieval fiefdoms as described by Machiavelli and the market-driven social self-organization first described by Adam Smith in the 18th century, through Max Weber’s admonitions and the teachings of Catholic Social Thought in the 1900s, human centered management has become pivotal in both public service and private ventures. It is the foremost driver of collective well-being; and it is facilitated best when the direct action of ordinary people organized into groups and associations concurs with judicious guidance of these groups and associations through (elected) government.

There will always be recurrent debate over what should be managed by governments and what by self-organization, but all critics agree that for collective well-being to thrive, a consensus between the public and the private sector is needed. The main task is for responsible leaders in government and business to stimulate and communicate a commitment not just for doing good but for rewarding good behavior and punishing evil. Morality will thus become a public good.

In business, a leader’s company must “walk the talk” through conduct that earns higher levels of trust, through responsible caring, through authenticity, by eliminating negative ties and building coalitions for positive change and by aligning mutual expectations. Responsible leadership thus furthers the embeddedness of an organization as a trustworthy business in society. Society will reward honesty, fair-dealing, justice and exercising the nonobligatory virtues of benevolence and charity. Proof of this is shown in the many cases where companies that reached out far beyond their business environment not only received recognition but also gained new customers or more orders.

There are the examples of manufacturers that gave away new products free of charge to people who would never become their customers, as Burlington did in Somalia (Charter et al. 2002) or Chevron’s support for reducing HIV/AIDS in Angola (Connor, Evans, and Brink 2011). But reaching out beyond the immediate business environment is not just an endeavor for big corporations. Small and medium enterprises play a vital role in giving back to the community, setting outstanding examples for responsible leadership and thus in upholding business morality. One might say that the public good of morality is best preserved by small and medium entrepreneurs. Two issues may explain why this is the case:

1. 1 Most small and medium enterprises (SMEs) are very active with respect to social responsibility. The societal expectation to them is higher, as they are closer to their stakeholders than big corporations (Whetten, Rands and Godfrey 2002). However, their involvement differs and may not be measurable in the same way and to the same extent as for large enterprises. They are visibly concerned with maintaining acceptance and feedback from the communities in which they operate – securing a license to operate (Russo and Perrini 2010). The instruments are personal informal communication by managers and employees, word of mouth or civic engagement by the owners in the local community who often need to respond quickly to the changing circumstances. Some research highlights that SMEs have nurtured “peculiar” corporate social responsibility (CSR) orientations revolving around intimate and personalized stakeholder while their CSR processes are almost not institutionalized (e.g., Jamali, Zanhour, and Keshishian 2008). In the developing world, where SMEs often differ from what is commonly encountered in industrialized countries and where the informal enterprises (particularly in the agricultural sector) exhibit different orientations to basic social and environmental functions (de Kok, Deijl, and Veldhuis-Van-Essen 2013; Demuijnck and Ngnodjom 2013), the individual history, values and ethics of SME owners play an important role in shaping their engagement in CSR (Jamali, Lund-Thomsen, and Jeppesen (2017).
2. 2 SMEs are directly affected by local politics, and the effects are immediate. Therefore they need to engage in almost all community affairs (Boiral, Baron, and Gunnlaugson 2014; de Oliveira and Jabbour 2017). Hence, while their engagement is mostly motivated for moral reasons, it will also pragmatically have the expectancy that the engagement will prove beneficial, for example, better schools provide a better workforce, better county ordinances provide better working conditions. SME associations have therefore welcomed the development of a best practice standard of social responsibility by the International Organization for Standardization (ISO), which was to become ISO 26000. SME associations were well represented on a worldwide scale in the multi-stakeholder working group on this international standard (Castka and Balzarova 2008).

International standards are public goods of their own as they disseminate guidelines and best practices to a very wide community. ISO 26000, as shown in Exhibit 4.3, attains a set of goals that all are related to ethical issues: human rights, labor practices, the natural environment, fair operating practices, good consumer relations and community involvement.

Exhibit 4.3 The seven core subjects of social responsibility in ISO 26000

Source: ISO (2010), p. 16

A standard like this will induce proactive social responsibility (Torugsa, O’Donohue, and Hecker 2013), that is, foreseeing and capitalizing on, rather than merely reacting to, emerging issues in the environment of a business. The general public and the stakeholders of the business will surely gain advantages from the various activities related to proactive social responsibility. The workplace in the firm and in its suppliers or customers will benefit from, for example, training and development opportunities within the firm and outside its boundaries; social cohesion will be created, capabilities will be built or be enhanced and best practices will be shared. This will also strengthen the institutions that encase and cooperate with the business sector – which brings us to the last of the four perspectives in conjoining morality and leadership: the institutional perspective.