Okay. For this video, we'll start with discussing The Pyramid of Corporate Social Responsibility. Throughout this course, we've talked about gaining and sustaining competitive advantage, and that's the responsibility of the managers. But the manager's responsibilities are much more than just the economic responsibilities. Clearly, they also have legal responsibilities. They have laws and regulations in place and they have to make sure that they stay within the guidelines of those rules and that also for the protection of the economic interest of the company as well. Beyond that, there's also the ethical responsibilities of doing what is right, just and fair. There's a very famous categorization scheme of knowledge by a person named Bloom, and Bloom had this taxonomy of knowledge. At the first level, is the level of description that's, do you understand the material and can you show that you have competence in the material? In many ways, what we're doing in learning this material is that fundamental level of knowledge. Going beyond that, you can also keep taking it up to the next level of analysis, can you take knowledge and take it apart and look at its individual parts? The next level is, can you take that and put a synthesis and put it back together? As an example, I would say when I was about 10 years old, I got very fascinated with my parent's phone. So I was very analytical and I took the phone all apart. But I found out at the time I was 10, I wasn't very good at synthesis because I couldn't put it back together the way it was and I originally started. Now beyond that, the next level is application. Can you take the knowledge that you had and apply it to a new situation? So that really shows a deep understanding. What made me think of Bloom's Taxonomy is actually ethical responsibilities is what Bloom would call the highest level in his taxonomy, and that is when a student starts to not ask the question, am I doing this right? They start to ask the question, am I doing the right thing? Then that's what Bloom regards as a very high level of education at that point when you start habitually think that way. At the highest level, it's even beyond doing the right thing within the organization itself, is there are question of, are you doing the right thing for others beyond the corporation? Or is the organization a corporate citizen not only to the corporation itself, but is it a corporate citizen to the world beyond the boundaries of that corporation? Your question then goes to a comment by Milton Friedman, a famous economist, Nobel Prize-winning economist from University of Chicago, who stated that "the only social responsibility of business is to increase profits so long as it stays within the rules of the game." So the question is, are philanthropic responsibilities part of the public corporations responsibility, or is its only social responsibility to increase profits? Please reflect on this question and post your response in the discussions for this video. Thank you. So Milton Friedman circa 1962, noted as, ''The only social responsibility of business is to increase profits.'' This is probably often is left out of the quote. ''So long as it stays within the rules of the game.'' So he does have an ethical aspect to it, but not good. But just staying within the legal boundaries and making profits. So in some sense in our pyramid, it's really mostly the first two levels; the economic responsibility, the legal responsibility. So the issue then is for today's businesses, it tends to be more than just making profits. So the question is, does corporate social responsibility or CSR, help build competitive advantage? Then the answer also might depend on where you do business. So for example, United Arab Emirates, Japan, and India are less interested in corporate social responsibility. While other countries like China, Brazil, and especially Germany are more interested in CSR. Here's an example here of a survey done, recent survey done, and ask the question about whether you agree or not that the social responsibility of business is to increase profits, which is at least somewhat agree that there's social responsibility of business. So United Arab Emirates is at one extreme focusing mostly on profits. But you have other companies to the right of the US such as China, Brazil, Germany, Italy, and Spain, with Spain being the most social responsibility oriented managers on average, and United Arab Emirates being at the other extreme in the variance in this figure. So corporate social responsibility then can also be considered in terms of a value creation framework, and that framework would consider the following. What's your customer base and how are you bringing in non-consumers, expanding the internal firm's value chains by including more non-traditional partners and focusing on creating new regional clusters? In other words, generating a larger base for the reach of that or sometimes called the footprint of the organization. So some companies actually try to reconcile the shareholder and stakeholder view. A company like General Electric, for example, recognizes explicitly a desire for a convergence between a shareholder and stakeholder perspectives. That is looking for actions that are win-wins for both the shareholders and other stakeholders. So there's a whole empirical literature on this. In general, the findings are that firms that tend to do well, financially, they also do well by having some attention to corporate social responsibility. Now the question is whether they're intrinsically motivated to do that or whether they're extrinsically and instrumentally doing it just because they know it helps their bottom line. But in some ways, the answer to that question, it's not essential for the observation that companies, whatever their motives that have corporate social responsibility, tend to have better financial bottom lines. To finish up this particular video, we'll look at the issues of corporate governance. So you've heard this term probably a lot throughout the course. Here, let's formally define it. The corporate governance represents the relationships among the stakeholders that is used to determine and control the strategic direction and performance of the organization. I referred to it also earlier as thinking about it as the rules of the game within the corporation itself. What are the responsibilities and duties of the board of directors and the managers, so forth? The other aspect is what are called agency costs. An agency costs are that the principal is the one paying to have something done and the agent is the one who does it and the question is, will the agent act in the interest of the principal? We talked a little bit earlier about the separation of ownership and control, so there, the agent is the manager and the principal is the shareholders, and will the manager act in the best interest of the shareholder? When they do not, that's referred to as agency cost. So how do you reduce the agency cost? That is, how do you get the ancient actually act in the way that the person who's paying wants them to act. So that there are few ways to do that. One is to provide the agent with more incentives, and so that'll be incentive cost. Another is the principal can monitor the agent's behavior more, and so that will be monitoring costs. There can be penalties for non-compliance and that's referred to as the enforcement cost. So let's take an example of a franchisor and franchisee. The franchisor of McDonald's is the principal, and the franchisee of the particular McDonald's store that you may attend is the owner of that particular store is the franchisee. Now the question is, how do you get the franchisee to act in the benefit of the whole system? Because if the franchisee does not, it will not only hurt that particular restaurant, it may hurt the entire brand name of McDonald's if a customer has a bad experience, and that one restaurant it may affect the whole system and word of mouth with other people. Now in the era of social media, the need for control of quality is even greater than ever. So McDonald's will use a mix of incentives, monitoring, and enforcement within their franchise contract as a way to try and get better performance. All of those costs that McDonald's incur and that franchisor-franchisee relationship are called agency costs. Now, there are different corporate governance mechanisms that can be used and we'll talk more in our final video about some of these mechanisms. But just for now, the different ways that the corporation tries to minimize the cost are referred to here as mechanisms to direct and control the firm. The objective of these mechanisms are to ensure the pursuit of the strategic goals of the company, that is they wanna do certain things, how are they going to implement and get what they want. In particular, and specifically we're addressing the principal agent problem. How do you minimize the agency cost? How do you minimize the sum of the monitoring cost, the enforcement cost, and incentive cost within the organization? So at its larger level, what we're talking about is if you have really good corporate governance. You're less likely to have accounting scandals like we had at Enron, less likely to have global financial crisis. For Bernie Madoff who was very well known or infamous, I guess, more than famous for having a Ponzi scheme or a scheme that was a pyramid scheme of taking some money to pay others to pay out. But you never really have enough money to cover and your debt keeps getting worse as you go along. So that's a severe agency problem. In that example, Bernie Madoff was just trusted by all the principals who gave Bernie Madoff money, no one was checking the books, no one was monitoring him and so that really gave him a lot of leeway for egregious behavior. The central concept at an abstract level is that of asymmetric information. That is Bernie Madoff has all the information and doesn't give any of it out, no one's monitoring him, and then he takes advantage of that asymmetric information. Another example of asymmetric information is those who buy and sell stock, who get inside knowledge within the accounts. It's not really a fair playing field for buying and selling of stock, and there's insider information at some point will be defined as illegal activity. If a person is caught with buying and selling with insider information, then they have severe penalties for that. Finally, to finish up this section, once again, we've been using the term agency theory a lot. So agency theory then views the firm as a nexus that is a bundle of legal contracts. So the employees have legal rights. The customers, when they buy a product, have legal rights for having certain expectations. If you buy a ladder and the ladder collapses and you get harmed, you may have strong recourse from the firm for compensation and so forth. So there's relationships and thought of as contractual relationships among all the stakeholders of the firm. Some are explicit contracts and some are implicit contracts, but the law will treat them all as types of contracts that have their own sets of responsibilities and obligations. When we talk about asymmetric information problems, there's two types of agency problems in particular and one is called the adverse selection problem and the other is the moral hazard problem. Within the context of the employment relationship and adverse selection problem is perhaps someone misrepresents their abilities to the employer. So we're asking, are you an architect? The person says, "Yes. I'm an architect," and they started then later on, they discovered they don't actually have an architectural degree. That would be a misrepresentation. The other type of thing that can happen is even if you are an architect, once on the job, if there's any kind of slacking or shirking or not putting in very much effort, and that is referred to as a moral hazard problem. So those will be two of the challenges. When we finish up on our last video, we're talking about mechanisms to reduce asymmetric information and agency problems and in particular, reducing these adverse selection and moral hazard problems.
