Deck 5: Business Case Studies

Question 1

Too much pressure. Hank Kolb was put in charge of quality assurance at a plant where practices were not up to par. The most immediate issue facing him was what to do about some pressurized cans of lubricant that had just been shipped out. The cans had been overpressurized by faulty equipment. When this was discovered, one of the production supervisors vented the excess by hand without taking measurements to make sure the pressure was within tolerances. One option was to recall the cans and check them systematically, but this would be an expensive and time-consuming process, and it would antagonize customers. Should Kolb recall the cans?
Hints. See Case 6.2 for guidance on how to analyze this case. The utilitarian test can perhaps be applied by the use of statistical sampling to estimate the cost of possible injuries. Kolb could recall a random sample of the cans for this purpose. However, you must ask whether statistical sampling alone can enable Kolb to promise safety, as required by the generalization principle, or whether a complete recall is necessary. Statistical sampling presupposes that uncontrolled defects are random.

Answer 1

Case Summary:
Mr. Hank Kolb is the incharge for quality assurance at a plant that provides pressurized cans of lubricants and generally practices at this plant is not at par the standards. He is worried about the recent shipped out cans of lubricants which have been over pressurized due to faulty equipment. When this fault was discovered, the production supervisor vented out the excess pressure by hand but there was no typical or specific measurement of the pressure left in the can. Thus he is dilemma to call for all the shipped lubricants and antagonize the customers or should wait for complaints from them.
Conclusion:
As per this case, Hank Kolb should be ethical in his decision making and he should call for few samples and check the quality of them. If the cans prove to be capable of handling the pressure given to them, then nothing needs to be worried for. But if these samples show default and the cans are not capable of handling the excess pressure then without wasting any more time, he should call the shipped out cans from the customers and make the necessary changes to these cans of lubricants before shipping it again. The customers would be more than happy to hear from the supplier about the default and that the lubricants will be checked, maintained and then re-shipped to the customers once again.

Question 2

Fraud at lnterspeed Corporation. Inters peed Corporation had just gone public, and Senior Vice-President for Sales Arthur Goodwin was keen to meet annual revenue targets. The fourth quarter target, for example, was $3 million, but the books showed only $1.9 in revenue. Goodwin decided he had to do something. He persuaded Solunet Inc. to take delivery of $1.2 million in inventory and hold it until another Interspeed customer bought it shortly after the new year began. Solunet was allowed to return the goods to InterSpeed if it couldn't sell them to the third party. Goodwin counted the $1.2 million as revenue and so pushed fourth-quarter revenue to $3.1 million, slightly above the target. Goodwin's conduct was a clear violation of GAAP. Solunet didn't actually buy the goods, because it didn't commit itself to paying for them. So there was no revenue to report.
As it turned out, the customer Goodwin counted on wouldn't buy the inventory. So Goodwin arranged for another company, I-Way, to buy or lease the equipment. When I-Way could not come up with the money, Goodwin transferred funds to I-Way, which leased the goods from a leasing agent. The leasing agent bought the goods from Solunet, which used the money to pay Interspeed, completing the circle.
Goodwin kept digging himself into a hole. In another incident, he forged a signature on an altered contract to create the impression that Interspeed had made a $6.4 million sale. Before it was all over, he had overstated the company's revenues by 60%, or $9 million. In a June 2006 Federal jury trial, Goodwin was convicted of securities fraud for his activities at Interspeed. He was sentenced to 30 months in jail, followed by a three-year supervised release. The Securities and Exchange Commission (SEC) also brought a civil action against Goodwin for the same offenses. In May 2007, he settled with the SEC by agreeing never to serve as an officer or director of a public corporation and by turning over $100,521 in earnings that resulted from his fraud. The payment was waived on grounds of financial hardship.
It doesn't take rocket science to show that Goodwin's conduct was unethical. In fact, the business scandals we hear so much about may give the false impression that it is normally easy to recognize the right decision. We hear about these scandals precisely because they make a sensational story of egregious wrongdoing. Many real-life decisions are murky and difficult to sort out even when one has the best of intentions. In the Interspeed case, for example, there are several hypothetical scenarios in which the right decisions would not be so clear:
a. Interspeed would be forced into bankruptcy if it didn't show additional revenue in the current period, but it has very good prospects for the future.
b. In addition to the previous scenario, Interspeed makes products that save lives.
c. There is a signed contract in which the third party agrees to buy the goods at the beginning of the new year.
d. Interspeed offers Solunet a percentage of the final sales for buying the product before the end of the year and passing it on to the other customer at the beginning of the new year.
Your task is to analyze the case under each of these scenarios.
Hints. For Scenario (a), look at the conditions under which income smoothing can be ethical in the analysis of Case 6.1. Scenario (b) asks in effect whether the end justifies the means, an issue discussed in Chapter 2. You must test the generalizability of fudging numbers when saving lives is part of the rationale (i.e., part of the scope). Note that saving lives is part of the scope only if Interspeed would avoid fudging numbers if its existence as a company were at stake, but lives were not. You may assume that the scheme in Scenario (d) is consistent with GAAP.

Answer 2

Case Summary:
Senior-VP for Sales Mr. Arthur Goodwin is convicted of doing a fraud with the company for which he works for "Interspeed Corporation". He has brought a vicious circle just to meet the annual target set for the company through sales. He made use of several companies like Solunet Inc., I-Way, etc. which is clear violation as per the rules and regulations of Gap. In one of such incidences, Goodwin has also been sentenced a 30 month jail after his frauds came into light. The Securities Exchange Board (SEC) sued Goodwin for his wrong and unethical conduct several times. He has been charged of showing false earnings through wrong sources.
Conclusion:
As per the above case, I completely boycott people like Goodwin who had been using his post and its power in undertaking fraudulent purposes and actions just for the sake of showing that his department has met the target set for it. The kind of vicious circle of investment that he has intentionally created by duping his own company is completely unethical and proper actions needs to be taken against him.
The SEC took a good decision by charging Goodwin of the frauds that he undertook being at Interspeed Corp. and the jail sentence that he was termed also gave a good lesson to him. Thus this way, SEC and Interspeed Corp. could hope that Goodwin will change his ways and become ethical with his business sealings.

Question 3

Celebrity endorsement. L L Advertising just signed a contract with movie star Lance Willard for celebrity endorsements of Bud's Best bacon. The president of the firm assigns the account to Annie, who soon learns the awkward fact that Lance has just become a vegetarian. The president assures her that all legal requirements for the endorsement are satisfied, but Annie is uneasy and consults the American Advertising Federation's Advertising Ethics and Principles. It states that "advertising containing testimonials shall be limited to those of competent witnesses who are reflecting a real and honest opinion or experience." When Annie interviews Lance, he assures her that Bud's Best has been his favorite brand of bacon since he was a kid. However, he learned during a recent medical checkup that his cholesterol is dangerously high, and his doctor advised him to avoid such high-cholesterol foods as bacon and eggs.
He decided to avoid all meat, for good measure. Annie diplomatically asks Lance if he is comfortable endorsing bacon. Lance responds that his conscience is clean, because he will describe only the taste and quality of the product, which he genuinely believes are tops, and say nothing about whether bacon is healthy. If consumers are going to eat bacon, they may as well eat the best. Besides, many persons can eat a reasonable amount of bacon without adverse health effects. It is up to consumers to decide what kind of diet is right for them. Is it ethical for L L to use Lance's endorsement? Is it ethical for Lance to give it?

Answer 3

Case Summary:
Movie Star lance Willard is consulted for a TV commercial (ad) and its endorsement for Bud's Best bacon. And the agency that is responsible for the production of this ad is L L Advertising. Annie works in this agency and has given the account for this ad. Annie comes to know that lance has recently become vegetarian and thus she consults American Advertising Federation's Advertising Ethics and Principles guidelines that suggested that ads should provide for real, honest experience of a product or a service by a person endorsing it. Thus Annie consults Lance who assures her that this brand of bacon was used to be his favorite all his childhood and he prevents eating eggs and meats just to control his cholesterol. Thus lance is going to give his true, honest experience about bacon referring to its taste and overall experience but he will not speak whether it is healthy or not.
Conclusion:
As per my opinion, Lance Willard should endorse this bacon brand and even L L Advertising should cast lance for this TV commercial. This is because Lance possesses the taste and experience of this brand of bacon and he just stopped eating it because of his health issues. And thus it is completely fair for lance to advertise and endorse this product as he is not going to say anything about the healthy composition of bacon and the customers are left with to choose what amount of bacon they wish to eat.
Thus due to above mentioned reasons lance should endorse this bacon brand and even L L Advertising should take him for this endorsement.

Question 4

Deterring car theft with Lojack. Lojack is a hidden radio transmitter device used for retrieving stolen vehicles. Because a potential thief cannot tell whether Lojack has been installed, it is not a deterrent to stealing a particular car. However, statistical analysis shows that the presence of Lojack in many cars deters theft generally. Automobile insurance companies can provide an incentive for car owners to install Lojack by giving a price break to those who do. This benefits the community as well as the insurance companies.
However, an individual insurance company does not have a clear incentive to provide a rate differential. Unless it dominates the market, the reduced premium will reduce its own revenues while having only a small effect on theft-probably not enough to compensate for the revenue loss. Customers with Lojack are more likely to get their car back, and this may result in smaller claims to the company. But this doesn't justify a rate differential large enough to reduce the rate of car theft. Thus in the absence of a dominant player, none of the insurance companies have an incentive to take an action that would be mutually beneficial if they all took it. Do insurance companies have an obligation to provide a rate differential when such a pricing scheme, generally adopted, would make everyone better off?
Hints. Don't just say, "This is the government's responsibility." Such a claim requires argument, and even if it is true, private insurers may be obligated to take on the responsibility if the government doesn't act. Also, recall that the utilitarian test doesn't ask how much utility is created if all companies provide a rate differential, but how much is created if one company (the decision maker) does so.

Question 5

The MasterDept lockbox problem. Master Debt, a credit card company, receives thousands of payment checks from cardholders every month. The company wants to exploit float so as to earn as much as possible in interest and fees. Float is the time lapse between the deposit of a payment check and crediting the amount to MasterDept. Cardholders pay interest on any outstanding balance, and MasterDebt wants to maximize float to collect more interest from them, and perhaps late fees as well.
The plan is to maximize float by establishing lockboxes in several cities. Cardholders in each region will be instructed to send their checks to a certain lockbox, perhaps a distant one to maximize float. The company is considering six cities as possible lockbox locations, each of which carries a certain annual fixed cost. The company asked its technical staff to select lockbox locations and assignments that maximize the difference between interest earned from float and the cost of the lockboxes. The solution is far from obvious, but the lockbox problem can be formulated as an uncapacitated facility location problem, a well-known mathematical model used in operations research. Solution of the problem reveals that the location of the lockboxes makes a substantial difference in net benefit to the company.
Lockbox location problems have been solved for many years but raise ethical issues. The interest gained by Master Debt is interest lost by its customers. One can ask whether MasterDebt has the right to collect this interest at the customer's expense. But this is only an assertion, not an argument. Even if we accept it, we must decide how much delay is artificial. Two days? Three days? There are also legal issues involved, partly due to new credit card regulations recently enacted in the United States. We take it for granted that credit card companies should abide by regulations. Let's focus here on what would be their ethical obligations without specific laws governing the float period. Your task: arrive at an ethical lockbox location and assignment policy.
Hint. Delay in processing checks incurs social costs because it introduces uncertainty, makes it more difficult for people to manage cash flow, and may result in less-than-optimal use of their funds. The interest earned by the credit card company due to delay may be a rough indication of these social costs, which can be balanced against the cost of locating lock boxes close to customers. Utility might be roughly maximized by modifying the facility location model so that it minimizes the sum of the interest cost to consumers and the cost of the lockboxes. You should also apply the generalization principle and virtue ethics (think about why we have financial services professionals).

Question 6

Insider trading. On November 17, 2008, the SEC filed charges against Mark Cuban for insider trading. The SEC complaint said that Momma.com, an Internet search engine firm, gave Cuban advance notice of a stock offering at below-market price, on the condition that he would keep this information confidential. Cuban already held a good deal of stock in the company and predicted that the new offering would bring down the market price. As a result, he sold all of his stock. The market price in fact fell the day after the offering was announced to the public. Cuban's early sale allowed him to avoid losses of $750,000. An SEC official stated, "Mamma.com entrusted Mr. Cuban with nonpublic information after he promised to keep the information confidential. Less than four hours later, Mr. Cuban betrayed that trust by placing an order to sell all his shares. It is fundamentally unfair for someone to use access to nonpublic information to improperly gain an edge on the market."
Mark Cuban (allegedly) broke the insider trading law, which is unethical because breaking the law is normally ungeneralizable. But is there anything inherently wrong with insider trading? Would it be ethical if it were legal?
Hints. Several arguments, summarized below, have been advanced against insider trading. Do valid applications of the conditions for rational choice underlie any of these arguments?
• It reduces utility. If the trade affects the stock price, a major stockholder can dump his holdings just before bad news is released to the public. This could depress the stock price even more and harm the company. Yet some economists argue that insider trades make everyone better off in the long run because the market has more and earlier information about the company, which leads to more rational investment. If an insider trade has no effect on the stock price, then the trade benefits the trader and presumably hurts no one. (Remember that the utilitarian test is not whether a general practice of insider trading maximizes utility, but whether a particular investor's trade does so.)
• It results in an "unlevel playing field" or, to quote the SEC official, is "fundamentally unfair." Should we treat investment as a competition or sports event that has to be "fair" in some sense? Some argue that if inside trading were standard practice, fewer ordinary investors would buy stocks, because insiders would reap a greater share of the rewards of investing, and less capital would be raised. (Note that the generalization test doesn't ask whether the market would be less efficient, but whether one can rationally believe that inside traders would still be able to achieve their purpose of making more money.)
• It is misappropriation of company information, which is shareholder property, and is therefore essentially theft. Can information about company plans be viewed as property?
• It violates fiduciary duty when the insider is a company officer, because insider trading can harm the company more than it benefits the trader. This doesn't apply to Mark Cuban, but is it a valid argument for company officers?
• It redistributes wealth unjustly because it benefits wealthy inside traders at the expense of small investors.

Question 7

Consulting for Carnegie Foods. The Pet Food Division of Carnegie Foods operates the world's second largest pet food cannery at Allentown, Pennsylvania. It ships to five regional distribution centers, which serve such customers as Wal-Mart (40% of its business), BJs, Target, Costco, and others. Despite inventory levels that are substantially higher than the industry average, the company has experienced difficulty maintaining the service levels its customers want. Wal-Mart, in particular, demands a high service level, and it usually gets what it wants due to its market dominance.
Adroit Consulting has been engaged to advise the Pet Food Division on how to manage its supply chain to reduce inventory and improve service. One option that is being pushed internally is to install a two-tier system in which a holding warehouse is placed between the cannery and the distribution centers. Adroit must evaluate this proposal as part of its recommendations. In the meantime, Carnegie Foods has authorized its chief information officer (CIO) to acquire Advanced Planning-and Scheduling (APS) software to manage its supply chain. Due to limited resources, the company will not implement APS and Adroit's recommendations simultaneously, and Adroit must advise which to do first.
The case raises at least two ethical issues:
• Should Adroit advise Carnegie to use APS, perhaps at the cost of losing a customer? Supply chain systems like APS are well developed; it is very possible that once Carnegie implements APS, it will have no further need for Adroit's supply chain recommendations.
• Is it ethical to provide Wal-Mart better service than other clients simply because Wal-Mart has the clout to demand it-even though Wal-Mart is paying the same price as the others, or even less?

Question 8

Writers' strike. On November 5, 2007, the Writers Guild of America, representing 12,000 writers, struck the Alliance of Motion Picture and Television Producers. A key issue in the strike was the writers' demand for residuals from distribution of their work in "new media"-Internet downloads, Internet Protocol TV (IPTV), streaming video, smart phones, and on-demand cable/satellite programming. The Writers Guild asked for 2.5% of gross income from new media. Writers are normally paid a percentage of future revenues, but excluding those from new media. Is it ethical for a recording studio to keep making money on their work without compensating them?
Hints. It is not enough simply to say that fair compensation is whatever the market dictates. Any such claim should be defended by appeal to the conditions of rational choice. The outcome may depend on some factual issues. To deal with this, analyze the case under the four scenarios in Table 6.2, where the propositions (a) and (b) are:
a. There is reason to believe that paying writers the 2.5% would create more overall utility, because they are currently underpaid and spend much of their time making ends meet by other means.
b. There is reason to believe that the movie/television industry as a whole would not be profitable enough to attract investors if all executives paid writers the 2.5%.

Question 9

Retrocession. A large private bank employs relationship managers (RMs) who work with high net worth individuals. The RMs help their clients to manage their substantial wealth, avoid taxes, and so forth. When the clients invest in certain funds, the fund owners remit retrocession payments to the bank as a reward. Consequently, the bank provides its RMs a financial incentive to recommend funds that provide retrocession. In theory, this need not create a conflict of interest for the RMs, because it could incentivize them to recommend a fund with retrocession only when there is a choice among equally attractive investments. It is widely suspected, however, that some RMs bias their recommendations to favor investments that yield them a higher commission. Is it ethical for the bank to provide this kind of incentive?

Question 10

Tax avoidance. The private bank mentioned in the previous exercise has a number of European clients for whom it provides substantial tax savings. By exploiting loopholes in complex tax laws, the bank allows some of its wealthy clients to avoid the high tax rates prevalent in their home countries. In some cases, clients pay only a small fraction of the tax they would otherwise owe. Yet these clients achieved their success due, in part, to services provided by their home country. They benefited from an excellent state-funded education and from a stable and productive economy that is highly subsidized and regulated by the state. Is it ethical for the bank to provide this kind of advice?
Hint. First analyze the taxpayer's obligation, and then address the bank's dilemma. Keep in mind that a private bank that fails to provide competitive tax advice is at a severe disadvantage for attracting clients.

Question 11

The Empire Globe Corporation. Susan Bond is Corporate Economist at Empire Globe Corporation, a chemicals company. CEO John Treadstone created the position so that he could have someone to help him with economic analysis of market trends and company proposals. Bond was attracted to the company by Treadstone's professed philosophy of creating a partnership with stakeholders. He created a "Partnership Conduct Team" consisting of four experienced managers, to develop ethical guidelines that exceed legal requirements and monitor compliance with them. Ten years ago, Treadstone located a processing plant in economically depressed Feldport, Oklahoma, against the advice of his staff, because he believed the company could create an effective partnership with the local players. In fact, they were so eager to attract jobs that the bank offered financing at discounted rates, the town council granted a five-year exemption from real estate taxes, the union (reluctantly) negotiated a no-strike clause, and the power company agreed to a low rate.
The Feldport plant has recently become an issue, however. As the special concessions expired, profit margins at the plant began to shrink. Treadstone set out to obtain similar concessions for the next few years. He indicated that if the company could not obtain adequate return on its capital investment, it would be obliged to relocate. The company managed to obtain most of what it wanted. The town agreed to a partial tax concession, the union ceded a cap on wages and reinstated the no-strike clause, and the bank provided further financing at below-market rates. However, Empire has not yet obtained the 4.25 cents per kwh rate it wants from the power company. To address this, Treadstone scheduled a negotiation session with the power company, involving himself, Bond, and Jim Doran, the VP for finance.
It is the day before the session. Bond is already concerned that the company is demanding excessive concessions from the community, but her discomfort grows when she receives a late-afternoon message from Treadstone. It states that he and Doran won't be present for the meeting, due to a commitment in Washington, DC, and that she is on her own. Furthermore, there's a change in strategy. She must obtain a rate of 3.80 cents per kwh.
The next morning, Bond cancels the meeting and contacts Ted Bates in the finance department to ask for data that might justify demanding a lower rate. Ted lets slip in the conversation that Empire has just landed a lucrative contract with the Defense Department that calls for a 25% increase in production at Feldport. She realizes that this was the agenda for the Washington meeting and that the threat to relocate is a bluff. She first tries to reach Doran, head of the negotiating team, but he finds himself too busy to talk about the issue. She finally calls Treadstone, who acknowledges the Defense contract when Bond brings it up. Bond asks him about his commitment to partnership, whereupon Treadstone responds that the low rate is necessary to justify his bid to Defense, and the added production will mean more jobs in Feldport. Besides, there is nothing wrong with making a profit, and they have obligations to their stockholders. Bond asks what happens if she is unable to get the 3.80 cents per kwh rate. Treadstone responds, "Susan, negotiating means getting agreements. Anything else on your mimi?"
Hints. The negotiation principles discussed in Case 6.3 may be useful. A utilitarian analysis can also be central to this case.

Question 12

Opt in or opt out. Countries typically use an opt-in or opt-out approach to organ donation. Opt-in countries give people an opportunity to sign a donor card to grant permission to us their organs. Opt-out countries assume that people give permission unless they fill out a form or make a phone call to revoke consent. Johnson and Goldstein report that organ donor consent is much higher in opt-out countries. If permission to donate is the default, people tend to let it stand. They are much more reluctant to give permission by overriding a default. Table 6.3 shows the rates for European countries. (The Netherlands' relatively high opt-in rate is due to an aggressive public campaign.) In the United States, an opt-in country, 85% of people "approve" of organ donation but only 28% grant permission. The article states that more than 45,000 people in the United States died in 1995 while awaiting a donor organ. It suggests that many lives could be saved by switching to an opt-out policy.
Because opting out requires some effort in Europe, one may ask whether the inconvenience of opting out explains the low rates. Johnson and Goldstein conducted an online survey of 161 U.S. respondents, who were asked to assume that they had just moved to a new state. Question 1 asked them if they would opt in to organ donation if given the opportunity. Question 2 asked if they would opt out. Question 3 asked how they would respond if required to choose whether to donate (with no default). The results (Table 6.4) show that only half as many people donate when required to opt in. Defaults therefore remain a key factor even when no effort is involved.
Is it ethical to use an opt-out system to save lives? Or is it dishonest? A rational agent would presumably make the same choice regardless of the default. The low opt-out rate suggests that an opt-out system plays on psychological factors that distort the agent's true intent. There are substantial opt-in/optout differences for online privacy, selection of insurance coverage, and the level of pension savings.
Hints. There are several possible explanations for why people opt out, such as:
1. It is too much trouble to opt out.
2. People don't want to think about the choice because of its emotional content.
3. People overlook the matter, perhaps because it is in "fine print," they are busy, or some other reason. Analyze the issue under each scenario.

Question 13

Preserving a culture. Bob Littman is owner of a series of galleries and a major client of Artifacts, an importer of ethnic arts. While having lunch with Mary, a manager at Artifacts, he is introduced to Len. A buyer for Artifacts, Len has traveled widely in South America in search of native artwork. One of his major sources is the Amazonia people, whom he has gotten to know quite well, even learning their language. Bob is very interested in Amazonia basketry and Indicates that he would like to place a series of large orders, provided the Amazonia will make certain changes in the patterns and colors of their baskets to suit the tastes of his customers. A deal of this magnitude would be highly profitable both for Artifacts and the Amazonia. Mary is enthusiastic about the idea. She proposes that Len return to South America and convince the Amazonia to modify their designs, which should be a minor matter given their obvious skills. Len, however, was an anthropology major in college and understands that the Amazonia basket designs are not just pleasing patterns. Symbolism plays a central and powerful role in many traditional cultures. The design elements that displease Bob contain symbols that denote important events in the group's long history. Even if the Amazonia agree to change their designs, he fears that they may not appreciate the risk of losing their symbolic tradition and the long-term impact on their culture. To make matters worse, meeting the production quotas would require that both men and women work on the baskets. Basket weaving is an integral part of a woman's role in Amazonia culture and never undertaken by men. The honor of preserving and celebrating the history of their people inspires women to spend a lifetime mastering the intricate designs. If Len explains all this to Mary, should she ask him to take this assignment? If she does, how should Len deal with the request?
Hint. A principle stated at the beginning of the next chapter may be helpful in analyzing this case.