Assignment:

Question #1: The MBA oath says in part, “My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.” This echoes what John Mackey of Whole Foods has in recent years called conscious capitalism.

One example of a large firm reorienting toward this approach is PepsiCo. In the last few years, PepsiCo has been contracting directly with small farmers in impoverished areas (for example, in Mexico). What started as a pilot project in PepsiCo’s Sabritas snack food division has now spread to over 1,000 farmers providing potatoes, corn, and sunflower oil to the firm. Pepsi provides a price guarantee for farmers’ crops that is higher and much more consistent than the previous system of using intermediaries. The farmers report that since they have a firm market, they are planting more crops. Output is up about 160 percent, and farm incomes have tripled in the last three years. The program has benefits for Pepsi as well. A shift to sunflower oil for its Mexican products will replace the 80,000 tons of palm oil it currently imports to Mexico from Asia and Africa, thus slashing transportation and storage costs.

Questions

1. What are the benefits of this program for PepsiCo? What are its drawbacks?
2. What other societal benefits could such a pro-gram have in Mexico?
3. If you were a PepsiCo shareholder, would you support this program? Why or why not?
4. Can you find other examples of firms employing “conscious capitalism”? 

Question #2: It is not unusual for even large corporate boards to have no women or minorities on them. In the US, women held 16 percent of board seats at Fortune 500 companies in 2012. In her 2013 book, Lean In, Sheryl Sandberg points out that this number has been flat for 10 years— or, as she puts it, there has been no progress in the past 10 years. In Europe, of the total number of board members in Britain, only 12 percent were women; Spain, France, and Germany all had less than 10 percent. In Norway, by contrast, female members comprised 40 percent of the boards.

So how did Norway do it? In 2005, the government of Norway gave public firms two years to change their boards’ composition from 9 percent female to 40 per-cent female. Is this a good idea? Spain, Italy, France, and the Netherlands must think so: Each country is considering implementing a similar quota (though generally with more than two years to implement it).

Questions

1. Discuss in your group to what extent it is a problem that women are proportionally underrepresented on corporate boards. Provide the rationale for your responses.
2. Why has representation by women on US boards not increased over the past 10 years? What actions could be taken by companies to increase participation? What actions could be taken by women who seek to be directors?
3. Would a regulatory quota be a good solution? Why or why not?
4. What other methods could be used to increase female and minority participation on corporate boards? Should it be perceived as a problem when a company seeks minority women as directors so that both statistics rise? What data would you gather in order to verify that such appointments are sincere?

Question #3: UBS was formed in 1997 when the Swiss Bank Corporation merged with the Union Bank of Switzerland. After acquiring Paine Webber, a 120-year-old US wealth management firm in 2000, and aggressively hiring for its investment banking business, UBS soon became one of the top financial services companies in the world and the biggest bank in Switzerland.

Between 2008 and 2012, however, UBS’s standing was harmed by a series of ethics scandals, detailed next. These scandals cost the bank billions of dollars in fines and lost profits, and severely damaged its reputation.

Ethics Scandal #1: US Tax Evasion Swiss banks have long enjoyed a competitive advantage brought by the Swiss banking privacy laws, making it a criminal offense to share clients’ information with any third parties. The exceptions are cases of criminal acts such as accounts linked to terrorists or tax fraud. Merely not declaring assets to tax authorities (tax evasion), however, is not considered tax fraud.

After the acquisition of Paine Webber, UBS entered into a Qualified Intermediary (QI) agreement with the Internal Revenue Service (IRS), the federal tax agency of the US government. Like other foreign financial institutions under a QI agreement, UBS agreed to report and withhold taxes on accounts receiving US-sourced income. Reporting on non-US accounts with US-sourced income is done on an aggregate basis. This in turn protects the identity of the non-US account holders.

In mid-2008, it came to light that since 2000, UBS had actively participated in helping its US clients evade taxes. To avoid QI reporting requirements, UBS’s Switzerland-based bankers had aided US clients in structuring their accounts to divest US securities and set up sham entities offshore to acquire non-US account-holder status. Aided by Swiss bank privacy laws, UBS successfully helped its US clients conceal billions of dollars from the IRS. In addition, UBS aggressively marketed its “tax saving” schemes by sending its Swiss bankers to the US to develop clientele, even though those bankers never acquired proper licenses from the US Securities and Exchange Commission (SEC) to do so.

The US prosecutors pressed charges on UBS for conspiring to defraud the United States by impeding the IRS. In a separate suit, the US requested UBS to reveal the names of 52,000 US clients who were believed to be tax evaders. In February 2009, UBS paid $780 million in fines to settle the charges. Although it initially resisted the pressure to turn over clients’ information, citing the Swiss bank privacy laws, UBS eventually agreed to disclose 4,450 accounts after intense negotiations involving officials from both countries. Clients left UBS in droves: Operating profit from the bank’s wealth management division declined by 60 percent or $4.4 billion in 2008; it declined another 17 percent ($504 million) in 2009. The UBS case has far-reaching implications for the bank’s wealth management business and the Swiss banking industry as a whole, especially for the bank secrecy in which the industry takes such pride.

To close loopholes in the QI program and crack down on tax evasion in countries with strict bank secrecy traditions, President Obama signed into law the Foreign Account Tax Compliance Act (FATCA) in 2010. The law requires all foreign financial institutions to report offshore accounts and activities of their US clients with assets over $50,000, and to impose a 30 percent withholding tax on US investments or to exit the US business altogether. Switzerland has agreed to implement the FATCA. The annual compliance cost for each Swiss bank is estimated to be $100 million.

Ethics Scandal #2: Rogue Trader

On September 15, 2011, UBS announced that a rogue trader named Kweku Adoboli at its London branch had racked up an unauthorized trading loss of $2.3 billion over a period of three years. Nine days later, UBS’s CEO Oswald Grübel resigned “to assume responsibility for the recent unauthorized trading incident.” [1] After more than a year of joint investigation by the UK and Swiss regulators, the case was concluded with findings that systems and controls at UBS were “seriously defective.” [2]

As a result, Mr. Adoboli, a relatively junior trader, was able to take highly risky positions with vast amounts of money. More alarmingly, all three of Mr. Adoboli’s desk colleagues admitted that they knew more or less of his unauthorized trades. Moreover, Mr. Adoboli’s two bosses had shown a relaxed attitude toward breaching daily trading limits. UBS was fined $47.6 million in late 2012.

Ethics Scandal # 3: Libor Manipulation. Libor, or the London Interbank Offered Rate, is the interest rate at which international banks based in London lend to each other. Libor is set daily: A panel of banks submits rates to the British Bankers’ Association based on their perceived unsecured borrowing cost; the rate is then calculated using a “trimmed” average, which excludes the highest and lowest 25 percent of the submissions.

Libor is the most frequently used benchmark reference rate worldwide, setting prices on financial instruments worth about $800 trillion. UBS, as one of the panel banks, was fined $1.5 billion in December 2012 by the US, the UK, and Swiss regulators for manipulating Libor submissions from 2005 to 2010. During that period, UBS traders acted on their own or colluded with interdealer brokers and traders at other panel banks to adjust Libor submissions to benefit UBS’s own trading positions. In addition, during the second half of 2008, UBS instructed its Libor submitters to keep submissions low to make the bank look stronger. At least 40 people, including several senior managers at UBS, were involved in the Libor manipulation. In addition to the fine, UBS Japan pleaded guilty to US prosecutors for committing wire fraud. UBS ended the year 2012 with a loss of almost $3 billion, compared with a profit of $4.5 billion for 2011.  

Questions

1. Mini Case 20 details three ethics scandals at UBS in recent years. What does that tell you about UBS?
2. Given the UBS ethics failings, who is to blame? The CEO? The board of directors?
3. What lessons in terms of business ethics and competitive advantage can be drawn from the UBS scandals, especially comparing the firm’s 2012 and 2011 net income? Looking at Exhibit MC20.1, why do you think the stock market hasn’t reacted more strongly to the ethics failings?
4. What can UBS do to a) avoid more ethics scandals in the future and b) repair its damaged reputation?

Question#4: HP was once so successful that it was featured as one of a handful of visionary companies in the business bestseller Built to Last, published in 1994. These select companies outperformed the stock market by a wide margin over several decades. Built to Last opens with a quote by HP’s co-founder Bill Hewlett:

As I look back on my life’s work, I’m probably most proud of having helped to create a company that by virtue of its values, practices, and success has had a tremendous impact on the way companies are managed around the world. And I’m particularly proud that I’m leaving behind an ongoing organization that can live on as a role model long after I’m gone. [3]

Bill Hewlett passed away in 2001. Much has changed since then. Although generally CEOs are blamed for a company’s poor performance, it appears that in the case of HP much of the blame is to be laid on the board of directors. The board is a key corporate governance mechanism that is supposed to act in the best interests of shareholders, but many of the HP board’s decisions contributed to the destruction of $82 billion in shareholder value. For the last decade, it appears that HP’s board of directors was dysfunctional. It started with the pretexting affair, followed by the handling of the Mark Hurd ethics scandal, the appointment of Leo Apotheker, and the botched Autonomy acquisition. In order to appoint a successor to Apotheker quickly, the board made the controversial decision not to engage in an open search for the next CEO but rather appoint Meg Whitman, who was serving as an HP board member at the time.

A closer look, for example, at the Autonomy acquisition in which HP lost some $9 billion shows that the due diligence process by the board was flawed. The process itself was truncated. Moreover, the HP board did not heed the red flags thrown up by Deloitte, Autonomy’s auditor. Indeed, a few days before the Autonomy acquisition was finalized, Deloitte auditors asked to meet with the board to inform them about a former Autonomy executive who accused the company of accounting irregularities. Deloitte also added that it investigated the claim and did not find any irregularities.

Perhaps most problematic, the board fell victim to groupthink, rallying around Mr. Apotheker as CEO and Ray Lane, the board chair, who strongly supported him. Mr. Apotheker was eager to make a high-impact acquisition to put his strategic vision of HP as a software and service company into action. In the wake of the Mark Hurd ethics scandal, an outside recruiting firm had identified Mr. Apotheker as CEO and Ray Lane as the new chair of HP’s board of directors. The full board never met either of the men before hiring them into key strategic positions!

The HP board of directors experienced a major shakeup after the Mark Hurd ethics scandal and then again after the departure of Leo Apotheker. Mr. Lane stepped down as chairman of HP’s board in spring 2013, but remains a director. [4]

Questions

1. Who is to blame for HP’s shareholder value destruction— the CEO, the board of directors, or both? What recourse, if any, do shareholders have?
2. You are brought in as: a) a corporate governance consultant or b) a business ethics consultant by HP’s CEO. What recommendations would you give the new CEO, Meg Whitman? How would you go about implementing them? Be specific.
3. Discuss the general lessons in terms of corporate governance and business ethics that can be drawn from this case.

Question #5: Developments after the global financial crisis moved the US away from being one of the most free-market economies in the world toward an economy with much more active and stronger government involvement (e. g., the “Patient Protection and Affordable Care Act,” commonly known as “Obama-care,” requires employers to spend more on health care, including smaller firms). What implications does this shift in the political and economic environment in the United States have for large firms (such as GE or IBM) versus small firms (mom and pop entrepreneurs and technology startups)? How does this change the competitive landscape and affect a firm’s strategy formulation and implementation?