Corporate Sustainability and Organizational Culture

“… findings suggest that the successful implementation of culture change for corporate sustainability might be largely dependent on the values and ideological underpinnings of an organization’s culture, and that these in turn affect how corporate sustainability is implemented and the types of outcomes that can be observed.”

Linnenluecke and Griffiths were interested in examining the relationship between corporate sustainability and organizational culture.  They observed that organizational culture had often been cited as the primary reason for the failure of implementing organizational change programs, and explained that regardless of the sophistication of the tools, techniques and change strategies used by an organization, change programs are most likely to succeed when they are aligned with the values and ideological underpinnings of an organization’s culture.  They believed that organizational culture impacts how corporate sustainability is implemented and predicts the types of outcomes that may be observed by introducing various change strategies into the organization.

In order to test these propositions, Linnenluecke and Griffith set out to explore and discuss the relationship between corporate sustainability and organizational culture using the “competing values” framework of organizational culture that has been used to identify and describe the following four types of organizational culture, each with its own set of valued outcomes and a coherent managerial ideology about how those outcomes could be achieved:

  • Human Relations Model: Organizations that are dominated by human relation values promote cohesion and morale through training and development, open communication and participative decision-making
  • Open Systems Model: Organizations that are dominated by open systems values promote growth and resource acquisition through adaptability and change, visionary communication and flexible decision-making
  • Internal Process Model: Organizations that are dominated by internal process values promote stability and control through information management, precise communication and data-based decision making
  • Rational Goal Model: Organizations that are dominated by rational goal values promote efficiency and productivity through goal-setting and planning, instructional communication and centralized decision-making

Linnenluecke and Griffith put forward the following theoretical propositions with respect to each of the four cultural types with respect to how the ideological underpinnings of the applicable organizational culture were likely to influence how sustainability will be implemented and the outcomes that can be achieved from the sustainability initiatives:

Human Relations Model: Organizations dominated by the Human Relations Model, with its emphasis on social interaction and interpersonal relations, rely more heavily on internal staff development, learning and capacity building in their pursuit of corporate sustainability.  Organizations with a strong focus on social or human relations values are likely to support or attract social entrepreneurship and leaders of these organizations will likely invest significant time and energy, often at the expense of neglecting business goals and objectives, in advocating corporate sustainability principles within the organization.  The challenge for pursuing sustainability within organizations with an embedded Human Relations Model will be resolving the tensions between creating a business venture and pursuing a social purpose.

Open Systems Model: Organizations dominated by the Open Systems Model place greater emphasis on innovation for achieving ecological and social sustainability as they pursued corporate sustainability.  In this instance, innovation is applied not merely to attain higher levels of eco-efficiency, but rather to develop products, systems and practices that “move beyond pollution control or prevention and allow the organization to operate within the carrying capacity of the natural environment by minimizing their resource use and ecological footprint”. As for social sustainability, the assumption is that the organization must recognize and embrace its responsibilities toward various stakeholder groups and the community in which they operate.

Internal Process Model:  Organizations dominated by the Internal Process Model have a preference for pursuing economic sustainability and thus place greater emphasis on economic performance, growth and long-term profitability in their sustainability initiatives.  The key aspects of this approach would be maximizing production and consumption of the organization’s products and services in order to increase profits and achieving economic efficiency through the simplification of products, services and processes in order to achieve costs reductions, maximize product and pursue economic outcomes; however, realization of economic sustainability (i.e., the maximization of profits, production and consumption) alone is not sufficient for the overall sustainability of corporations.

Rational Goal Model:  Organizations dominated by the Rational Goal Model emphasize resource efficiencies in their pursuit of corporate sustainability.  There is no doubt that there are operational and sustainability advantages to implementing policies and practices that reduce costs and operational efficiencies and many organizations have implemented human resources and environmental policies focused on reducing and eliminating waste; however, efficiency should not be pursued in isolation, since it is also necessary to consider the impact that the steps taken to achieve efficiency may have on the environment and society.  Moreover, efficiencies may be of limited competitive advantage to organizations if they can be easily copied and implemented by competitors.

The propositions for each of the cultural types championed by Linnenluecke and Griffith are important for sustainability leaders in the way they serve as reminders that there is no single best type of sustainability-oriented organizational culture and that organizational culture is best viewed as a fundamental influencer on how corporate sustainability is implemented and the types of outcomes that can be expected.  Can sustainability leaders make the changes in organizational culture necessary to facilitate a shift toward different sustainability-related ends?  Organizational rigidity and multiple subcultures make the task more difficult; however, Linnenluecke and Griffith suggested that certain changes can be made to the elements of an organization’s observable culture (i.e., at the surface level) to provide a conducive context for the changes in the values, beliefs and core assumptions of organizational members necessary to pursue sustainability: publication of corporate sustainability reports, the integration of sustainability measures in employee performance evaluation, and employee training.

Sources: A detailed discussion of the article appears in the chapter on “Organizational Culture and Sustainability” in “Organizational Culture: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org) and available for download here, and the article itself can be found at M. Linnenluecke and A. Griffiths, “Corporate sustainability and organizational culture”, Journal of World Business, 45 (2010), 357.  For further discussion and description of the competing values framework of organizational culture, see R. Quinn, Beyond rational management: Mastering the paradoxes and competing demands of high performance (San Francisco, CA: Jossey-Bass, 1988); R. Quinn and J. Kimberly, “Paradox, planning, and perseverance: Guidelines for managerial practice” in J. Kimberly and R. Quinn (Eds.), Managing organizational translations (Homewood, IL: Dow Jones-Irwin, 1984), 295; and R. Quinn and J. Rohrbaugh, “A spatial model of effectiveness criteria: Towards a competing values approach to organizational analysis”, Management Science, 29(3) (1983), 363.  See also the chapters on “Dimensions of Organizational Culture” and “Typologies of Organizational Culture” in Organizational Culture: A Library of Resources for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).

 

 

Networking and Leadership Development

Hoppe and Reinelt suggested a framework for classifying networks with a particular focus on networks that organizational leaders might join as part of their leadership development efforts in order to gain access to resources and other support.  They noted that while leadership networks may be intentionally created, they also often emerge from a strong need or desire of the members of the networks to become and remain connected.  The four types of networks in their framework were as follows:

  • Peer Leadership Network: A peer network is based on social ties among leaders who are connected with one another on the basis of the shared interests and commitments, shared work, or shared experiences. A peer network provides leaders with access to resources that they believe are trustworthy and can be used by leaders to share information, provide advice and support, learn from one another and collaborate together.  Gaining access to a peer network is often one of the fundamental goals of a leadership development program.
  • Organizational Leadership Network: The social ties established in an organizational leadership network are focused on increasing performance.  Ties in this type of network are often informal and exist outside of the formal organizational structure and provide leaders with the means to consult with colleagues outside of their departments or business units in order to solve problems more quickly.  In some cases, organizational networks are intentionally created, in the form of cross-functional teams or communities of practice, to bridge gaps in the formal organizational structure that may be impeding performance and progress toward organizational goals (e.g., completing a new product and/or delivering services to customers more efficiently).
  • Field-Policy Leadership Network: Leaders who share common interests and a commitment to influencing a field of practice or policy may come together to form a network that can be used to shape the environment surrounding the topic of mutual interest (e.g., frame the issue, clarify underlying assumptions and/or establish standards for what is expected of key stakeholders). This type of network can be a powerful tool for collective advocacy on issues and policies that are of common importance to multiple organizations and can facilitate mobilization of support and allocation of resources.
  • Collective Leadership Network: A collective leadership network, which is based on a common cause or share goals, emerges and enlarges over time.  The process begins with local groupings that eventually interact with groups in other areas to form larger networks and a much broader community that allows members to pursue specific goals while feeling a part of something that is larger than oneself.

Hoppe and Reinelt emphasized that the framework was largely for illustrative purposes and that many networks are actually hybrids of multiple categories or simply fail to fit neatly into one of their network types.  What is important from a leadership development perspective is the potential value of networks to current and prospective leaders in terms of access to information, advice, support and other learning benefits.  Networking also provides leaders with a foundation for identifying potential collaborators for new initiatives and impacting the external environment of the organizations they lead.

The relative position of leaders within their networks is an important consideration.  In some cases, leaders enjoy strong ties to others members of their network (“bonding connections”) and thus have a feeling of affiliation and connectivity to a trusted community where interactions are familiar and efficient.  However, leaders also need to have “bridging” or “brokerage” connections which, while weaker than bonding connections, nonetheless provide them with essential paths to accessing new resources and developing new opportunities for innovation and profit.  A “bridger” is a person in a network who has connections to different clusters and is typically someone who is deeply embedded in relaying information among other network members.  In this capacity, a leader can gain recognition and trust as a key broker of access and knowledge and as someone who is positioned to move projects that require collaboration from people in different parts of the organizational network.  As a leader’s reputation grows, he or she is more likely to become a “hub” in a network, which means someone who is a highly-sought resource for advice by other members of the network. The influence of a hub increases to the extent that the persons who seek his or her advice are themselves relatively more influential in the network.

To learn more, see B. Hoppe and C. Reinelt, “Social Network Analysis and the Evolution of Leadership Networks”, The Leadership Quarterly, 21 (2010), 600, 601.  This post is an excerpt from Chapter 2 (“Leadership Traits and Attributes”) of “Leadership: A Library of Resources for Sustainable Entrepreneurs”, which is prepared and distributed by the Sustainable Entrepreneurship and available here.

Becoming a Sustainable Leader

Sustainable leadership focuses on bringing about dramatic changes inside and outside organizations and calls for prospective sustainability leaders to be aware of the various traits, styles, skills and knowledge that he or she should have; the internal and external leadership actions that he or she should be taking; the leadership practices and principles that he or she should be following and disseminating and embedding throughout the organization; and the habits that have come to be associated with effective sustainability leadership.  There is no universal curriculum for becoming a sustainable leader and things like traits, actions and practices will vary depending on the personality and temperament of the leader and the context in which he or she is operating; however, the elements listed below are based on the work of several researchers who have analyzed the training, experiences and practices of sustainability leaders in organizations selected from many countries and sectors.  It is hoped that these elements can provide a foundation for the continuous study and work that is needed in order to become and remain and effective sustainable leader.

  1. Traits
  • Caring and morally-driven
  • Honesty and trustworthiness in actions and relationships (“keep your word”)
  • Systemic holistic thinker
  • Enquiring and open-minded
  • Self-aware and empathetic
  • Visionary, tenacious and courageous
  • Concern for disparities and injustices and commitment to human rights
  • Respect for diversity and different ways of working, cultures and mindsets
  • Passion for sustainability and commitment to a sustainable lifestyle
  1. Styles
  • Inclusive and engaging
  • Collaborative
  • Consensual decision making
  • Empowering and trusting
  • Visionary and creative
  • Altruistic (guiding and helping others with the ultimate goal of improving their wellbeing)
  • Servant (transcending self-interest to serve the needs of others)
  • Radical
  1. Skills
  • Manage complexity and unpredictability
  • Bridge disciplines and sectors
  • Communicate vision
  • Exercise judgement
  • Challenge and innovate
  • Staff and team management
  • Managing diversity in the workplace and socially
  • Think and plan long term
  1. Knowledge
  • Competence in domains relevant to organizational goals and purposes
  • Awareness of ecological, economic, political, cultural and community contexts
  • Global challenges and dilemmas
  • Interdisciplinary connectedness
  • Change dynamics and options
  • Organizational influences and impacts
  • Awareness of stakeholder roles and diverse stakeholder views 
  1. Internal Leadership Actions 
  • Organizational culture and reach
  • Informed decisions
  • Strategic direction
  • Governance structure
  • Role of leadership
  • Management incentives
  • Performance accountability
  • People empowerment
  • Learning and innovation
  1. External Leadership Actions 
  • Cross sector partnerships
  • Sustainable products and service
  • Sustainability awareness
  • Context transformation
  • Stakeholder transparency 
  1. Leadership Practices
  • Commitment to training and staff development programs
  • Proactively striving for amicable labor relations
  • Development of strategies for staff retention
  • Shifting compensation programs toward metrics that valued contributions to customer loyalty and to innovation
  • Promoting environmental and social responsibility
  • Initiating communications with multiple stakeholders and transparently taking into account and balancing their interests
  • Developing and embedding a shared vision for the goals of the business
  1. Habits
  • Taking a long-term perspective in making decisions
  • Fostering systemic innovation aimed at increasing customer value
  • Developing a skilled, loyal and highly engaged workforce
  • Offering quality products, services and solutions
  • Developing and maintaining the trust of organizational members and stakeholders
  • Committing to and engaging in ethical behavior and decision making and establishing ethical values and standards throughout the organization

For additional information, see W. Visser and P. Courtice, Sustainability Leadership: Linking Theory and Practice (Cambridge UK, University of Cambridge Institute for Sustainability Leadership, 2011), 1; G. Avery and H. Bergsteiner, “Sustainable leadership practices for enhancing business resilience and performance”, Strategy and Leadership, 39(3) (2011), 5, 6; and D. Timmer, J. Creech and C. Buckler, Becoming a Sustainability Leader (Winnipeg CN: International Institute for Sustainable Development, 2007), 56, 59.  To learn more about Sustainable Leadership, see the chapter on that subject available as part of “Leadership: A Library of Resources for Sustainable Entrepreneurs”, which is prepared and distributed by the Sustainable Entrepreneurship and available here.

Cross-Border Comparison of Directors' Fiduciary Duties

Directors around the world are expected to carry out their duties in accordance with applicable local standards of care and fiduciary responsibility; however, the specifics are not uniform and each jurisdiction has its own set of laws, norms and customs.  With respect to directors of companies in the United States, the Corporate Director’s Guidebook (Fifth Edition) succinctly describes the baseline standard for director conduct as requiring that directors discharge their duties in good faith and in a manner that they reasonably believe to be in the best interests of the corporation.  Directors owe a duty of care and a duty of loyalty to the corporation in discharging their obligations. As such, it is important that a prospective director consider whether or not he or she has the requisite experience to understand and participate in the deliberations of the board, as well as the time that is required in order for him or her to properly monitor and review the activities of the corporation. In addition, a prospective director who may become involved in business dealings with the corporation which may give rise to a conflict of interest must be prepared to fully disclose the nature of his or her interest and submit the transaction to a vote of the board of directors or, in some cases, the shareholders of the corporation.

While the duty of care and the duty of loyalty are the most well-known and widely discussed and analyzed legal obligations of US directors, the Corporate Director’s Guidebook (Fifth Edition) lists the following additional obligations that should be carefully understood by directors:

  • Directors have a “duty of disclosure” which includes an obligation to take reasonable steps to ensure that shareholders are furnished with all relevant material information known to the directors when they present shareholders with a voting or investment decision. In addition, in the course of deliberation regarding decisions relating to the corporation director have duty to communicate relevant information to their fellow directors and management.
  • Directors have a “duty of confidentiality” that requires that they refrain from public disclosure of all matters involving the corporation. The board should establish, and individual directors should abide by the terms of, confidentiality, insider trading and disclosure policies.
  • Directors have a duty to establish and monitor programs for identifying financial, industry and other business risks and for managing such risks to protect the assets and reputation of the corporation.
  • Directors have a duty to establish and monitor programs for ensuring that the corporation and its managers and employees comply with all legal requirements in the various jurisdictions in which corporation is conducting business activities.
  • Director of public companies have a duty to establish and follow appropriate procedures for ensuring that the corporation’s disclosure documents (e.g., annual reports, quarterly reports, current reports, proxy statements, prospectuses, and earnings releases) fairly present material information about the corporation and its business, financial condition, results, and prospects.
  • Directors have a duty to ensure that the activities of the corporation comply with relevant laws and regulations pertaining to employee safety, health and environmental protection and product safety. While this duty overlaps with the duties mentioned above relating to compliance programs the areas of concern are particular important because of their potential impact on the health and morale of employees and general business reputation of the company.
  • Directors have a duty to monitor the activities of officers and employees of the corporation with respect to participation in governmental processes, particularly efforts to influence legislative activities and/or the content and tone of regulations and activities designed to either encourage or prevent governmental action. Lobbying activities, including political contributions, can directly impact the reputation of the corporation and when carried out must be done in a manner that complies with applicable laws and regulations.
  • Directors have a duty to anticipate the unexpected and develop crisis management programs that can be quickly implemented upon the occurrence of a crisis event with respect to the corporation and its operations such as a natural disaster, terrorist activities, civil unrest or a significant adverse corporate development (e.g., a massive product recall or a infringement lawsuit by a third party threatening the validity of the corporation’s key patent rights).
  • Directors have a duty to act fairly and with the utmost integrity in overseeing deliberations regarding significant corporate events such as change-in-control transactions (e.g., proposed sale of the corporation) and election contests.
  • Directors have special duties of care during times when the corporation is experiencing financial distress and must be mindful of their expanded obligations beyond shareholders to include creditors and to do their best to ensure that the corporation is able to fulfill its legal obligations to all interested stakeholders.

Many of the duties described above are based on the federal securities laws and are particularly applicable to directors of public companies.

Outside of the US, the path for the development of the concept of directors having fiduciary duties has varied from jurisdiction to jurisdiction and the concept is still quite new in many countries.  The rationale for fiduciary duties is best understood from the experience in the US and the United Kingdom, both common law countries, where corporations arose as a means for separating ownership and management and it became clear that some legal framework was needed for the shareholders, as the owners of the corporation, to enforce standards of conduct upon the managers of the corporation.  The answer was to view the directors and officers of the corporation as trustees and as trustees these persons had a common law duty to act in the best interests of the shareholders, who were the beneficiaries of the corporation.  Eventually civil law jurisdictions, such as Germany, integrated concepts similar to fiduciary duty into their statutes and courts in those countries have developed those concepts through case law.  Emerging markets such as China often began by focusing on director conduct (e.g., having “high morals”, avoiding corruption and being “hardworking”) but eventually moved toward standards that emphasized protecting the lawful rights and interests of the corporation, its shareholders and others.

Today most countries around the world, regardless of their stage of economic development or their bias toward common or civil law, have laid out basic principles of fiduciary-type duties for directors and suggested skills, practices and processes that are likely necessary in order for director to effectively discharge their duties.  However, each jurisdiction is different and all of the following questions should be considered before selecting a foreign corporate entity for use as a subsidiary or the home for an international joint venture with a local partner:

  • What is the legal role of the board (or boards) of directors? Does the board collectively have responsibilities that are distinct from those of the directors individually?
  • Can the directors and/or the board (or boards) delegate any of their duties and if so, which ones and to whom, and are there any conditions attached to this delegation in terms of retaining overall responsibility for the action (or inaction) by the delegate?
  • What are the legal standards governing the conduct of directors in the performance of their fiduciary duties and do those standards incorporate a care/prudence element or equivalent (civil law) concepts?
  • Do these standards include good faith, ‘honesty of purpose’ elements and/or strictures against self-dealing or self-enrichment at a cost to the corporation and/or prohibitions on utilizing corporate opportunities for directors?
  • Is there jurisprudence that avoids “second-guessing” director conduct with the benefit of hindsight designed to limit judicial (or regulatory intervention that might chill legitimate business activity (e.g. the business judgment rule)? In other words, are decisions of the directors protected, provided that they have exercised their fiduciary duty and duty of care?
  • Are there any initiatives to codify (and/or simplify) the duties of a director? Is there any jurisprudence on how the courts have interpreted these codes or statutory provisions and, if so, have these led to contemporary governance best practice ideas being imported into court decisions?
  • Who can bring an enforcement action for a breach of duties by a director? Does the law entertain the concept of a derivative suit (an action brought by shareholders on behalf of the company) or is some form of private action available?
  • Can directors be held liable personally for a breach of their duties and, if so, can the company indemnify them and may the company, in turn, obtain insurance and are there limits imposed by statute or otherwise on the indemnity or insurance coverage (e.g. in cases of misrepresentation or fraud)?

The questions above are based on H. Gregory, C. Hansell and L. Hazell, “Comparative Analysis of Fiduciary Duty Papers”, International Developments Subcommittee of the Corporate Governance Committee of the American Bar Association Section of Business Law (2007), and a fuller discussion of cross-border comparison of directors’ fiduciary duties can be found in the article at § 33:252 of Business Transactions Solution on WESTLAW.

Federal Warranty Law

Products are generally marketed with, and supported by, various affirmative assertions from the seller with respect to certain characteristics of quality, safety, performance, and durability. These assertions, usually referred to as “warranties,” may be provided in written or oral form, although they are most commonly found in advertisements, brochures, and specification sheets. In fact, a warranty may also be derived from representations of the product in models and pictures.  Regardless of their form, warranties or guarantees are important promises by manufacturers or sellers to stand behind the products that they offer to consumers.

Whenever a transaction involving the sales of goods occurs, the parties must be mindful of various types of warranties codified in the general law of sales appearing in the Uniform Commercial Code (“UCC”), including the implied warranty of merchantability; the implied warranty of fitness for particular purpose; and any express warranties provided by the seller in connection with the sale of the specific goods or equipment, typically through affirmative written and oral statements regarding the quality of the items. While implied warranties, subject to applicable regulations, will often be modified or excluded, express warranties generally will be included to some extent in each transaction, primarily as a means of inducing customers to purchase the goods or equipment. As such, care must be taken in drafting such warranties and in designing appropriate remedies and rights for any breach thereof. For complete discussion of warranties under the UCC, see Sale of Goods (§§ 120:1 et seq.).

When writing a commercial or consumer product warranty the manufacturer or seller is faced with a complex set of decisions in determining what type, if any, written warranty to offer. Principally, these decisions will involve determining what combination of implied and express warranties to offer; determining whether to offer a full or limited warranty or multiple warranties on various parts of the product; and determining which disclaimers or limitations to include in the warranty. These issues arise in any sale of goods transaction; however, the focus of this chapter is on consumer product warranties.

Warranty provisions for a consumer sales transaction should be carefully drafted and the provisions should take into account not only the applicable legal requirements but also the business elements associated with providing warranty services to consumer customers. The essential elements of any warranty include each of the following:

  • Identification of the parties to the warranty agreement. This should include the name and address of the party offering the warranty and a description of the parties who may be entitled to the benefits of the warranty. The party providing the warranty should address the availability of the warranty to persons other than the original consumer purchaser or lessee and any conditions that need to be satisfied in order for the warranty rights to be transferred to any third parties.
  • Clear identification and description of the goods and related parts that will be covered by the warranty and, if appropriate, clear highlighting of any characteristics or components that are excluded from warranty coverage.
  • A clear and complete description of the warranties provided with respect to the covered goods and parts (e.g., the goods shall perform in accordance with the specifications etc.). In addition, the warranty statement should also include a clear and complete description of any actions or conditions that may invalidate the warranty, such as the failure of the consumer to use the goods in a certain manner or defects caused by any unauthorized service or repair of the goods.
  • A description of the remedies offered in the event that a covered good or part is found to be defective, malfunctions or otherwise fails to perform in accordance with the written warranty. In most cases, the warrantor will agree to replace or repair the covered items within a specified period of time; however, in limited circumstances, the warrantor may be willing to provide a refund of the purchase price.
  • Disclosure of the procedures that should be followed by the consumer to exercise its warranty rights, including identification of parties authorized to perform warranty services on behalf of the warrantor. The procedures should address the manner in which the covered goods are returned for warranty service, the amount of time that the warrantor will have to complete the warranty service and the procedures for returning the new or repaired items to the consumer purchaser. If the consumer purchase is required to bear any expenses, these should be clearly stated in the contract.
  • Disclose of the duration of the warranty and a clear description of the procedure for determining when the warranty period begins and ends. If any registration of the covered items is required, a statement to this effect should be conspicuously included along with clear procedures for completing the registration.
  • A description of dispute resolution procedures that can be used to resolve any questions regarding the performance of the covered goods and the warrantor’s fulfillment of its obligations with respect to providing warranty coverage.

Warranty provisions in consumer sales and lease agreements typically include additional language to address various legal requirements and risk-allocation issues. For example, the warranty should include any language mandated by applicable state law, such as a statement to the effect that certain states do not permit limitations on the duration of any implied warranties or the exclusion or limitation of certain types of remedies. In turn, state laws notwithstanding, the warrantor will almost always seek to exclude or limit incidental and consequential damages and cap the warrantor’s overall liability with respect to warranty claims at the amount actually paid by the consumer purchaser for the covered items.

In response to the widespread misuse by merchants of express warranties and disclaimers, Congress enacted the Magnuson-Moss Warranty Federal Trade Commission Improvement Act of 1975. [15 U.S.C.A. §§ 2301 et seq.; referred to as “the Magnuson-Moss Warranty Act” or “the Federal Act”] The Federal Act is based on the premise that suppliers of consumer goods vigorously use written express warranties as advertising and merchandising devices. If these warranties are to be used, they must meet federal standards in terms of disclosure and remedies provided to an aggrieved consumer.

The Magnuson-Moss Warranty Act regulates service contracts and written warranties on “consumer products” that are distributed in interstate commerce and mandates certain guidelines in connection with written warranties, regulates their disclosure to consumers, restricts conditions on warranties, imposes different requirements for “full” or “limited” warranties, and restricts the ability to disclaim or modify implied warranties.  The Federal Act does not require the tendering of a warranty on any product. However, if a written warranty is actually given to the consumer, the warranty and the services connected with it must meet certain specifications as implemented by the rules of the Federal Trade Commission (“FTC”). [16 C.F.R. Pt. 700 to 703]

The rules governing the contents of warranties [15 U.S.C.A. § 2303] apply only to warranties pertaining to consumer products costing the consumer more than $5; however, FTC rules regarding disclosure of written warranty terms [16 C.F.R. §§ 701.1 et seq.] and presale availability of warranty terms [16 C.F.R. §§ 702.1 et seq.] apply only to warranties pertaining to products costing the consumer more than $15. [16 C.F.R. §§ 701.2702.3]  Certain of the provisions dealing with designation of written warranties [15 U.S.C.A. § 2303] apply only to warranties pertaining to products costing the consumer more than $10. [15 U.S.C.A. § 2303(d)]

Consumers are given a federal cause of action for damages resulting from violation of the Federal Act or of a warranty or service contract regulated by the Federal Act, on which they may sue in an appropriate state or federal court. [15 U.S.C.A. § 2310(d)]  Given the legal requirements associated with warranties and the importance from a marketing perspective of issuing and servicing warranties in a lawful manner it is recommended that managers and other personnel responsible for warranties and service contracts offered by their companies familiarize themselves with the information and guidelines in the FTC publication called “A Businessperson’s Guide to Federal Warranty Law”.

When a company offers a product for sale, it should have a standard operating policy which describes the procedures for standing behind its products following their sale. The policy should be reviewed periodically for consistency with all product warranties and applicable law. When formulating a warranty policy, significant attention should be given to the business needs of the client, not just the requirements of the law. A warranty policy serves as a sales tool as well as a means to consciously allocate risk between a seller and a buyer for defective products. A poorly drafted warranty can reduce the sales potential for the company client as well as unnecessarily increase the risk of loss. With appropriate care in the warranty review, the attorney for the company can provide a very valuable service.  For further discussion on warranty law issues and practice tools, see Consumer Warranties (§§ 140:1 et seq.) in Business Transactions Solution on WESTLAW, which includes an executive summary for clients regarding federal warranty law (§ 140:61).

Board Responsibilities and Performance at Wells Fargo

The story of the sham accounts scandal at Wells Fargo Bank is really pretty simple.  An article published on October 13, 2016 in The New York Times explained it clearly: “Under intense pressure to meet aggressive sales goals, employees created sham accounts using the names—and sometimes, the actual money—of the bank’s real customers, and in some cases the customers did not discover the activity until they started accumulating fees.”  On September 8, 2016, it was announced that the bank had entered into a settlement agreement with the federal Consumer Financial Protection Bureau that included fines and other payments of $185 million and included an acknowledgement from the bank that thousands of its employees, reacting to intense pressure from management to meet aggressive sales goals, has opened as many as two million sham accounts without the knowledge of customers and had often opened those accounts by forging the signatures of those customers.

However, the settlement was just the first act in what has become a scintillating story of widespread criticism of the bank’s treatment of its customers and employees and, more importantly, the apparent failure of members of the executive team and the board of directors to effectively carry out their oversight responsibilities and respond appropriately to the situation.  On September 27, 2016, the bank’s board of directors announced that John G. Stumpf, the bank’s then-chief executive, would forfeit approximately $41 million worth of stock awards and receive no bonus for 2016.  The board also said that it was launching an investigation into the bank’s sales practices and that Stumpf, who already had been called before Congressional committees to explain what he knew about the fake accounts, would not receive any salary while that investigation was going on.  The board also announced that the former senior executive vice president of community banking, who ran the business unit where the fake accounts were created, would be retiring immediately and would forfeit $19 million in stock grants, would receive neither a bonus for 2016 nor any severance, and would be denied certain enhancements in retirement pay.

A little over two weeks later, Stumpf, who was famously told “you should resign” by Senator Elizabeth Warren during Senate hearings in early September, did just that.  Analysts praised the move, which was unexpected, as an opportunity for the bank to remove a significant distraction and move forward with rebuilding its reputation.  The board announced an extensive reshuffling of the bank’s top management team; however, for new leadership they stayed in-house and appointed Timothy J. Sloan, a long time insider, as president and COO and then CEO, but not chairman.  Critics expressed concern that Sloan was also culpable in the fraudulent accounts scandal, given his central role in what was clearly a flawed chain of command that should have stopped the misconduct from occurring and handled it better once it became a matter of public knowledge.  He was also on record as a staunch defender of cross-selling, was the face of the company in the departure of the head of the community banking unit and was a close ally of Stumpf who called his resignation “an incredibly selfless decision”.

Sloan was slow to act on making pronouncements about changes in the bank’s culture, a culture he was groomed in and helped to evolve and which has often seemed to be more interested in aggressively overwhelming and confusing customers as opposed to focusing on providing good service.  Early indications were that the quality of the customer experience would be given greater weight in compensation decisions, as opposed to qualitative metrics like numbers of accounts; however, while some claimed the change could take effect quickly others expressed skepticism given the embeddedness of the prior culture and the fact that bank leadership remained essentially unchanged even through roles and reporting channels among senior executives and managers were restructured with great publicity..

For her part, Warren wanted more from Stumpf: return of all the money he received during the scam and investigations by Securities Exchange Commission (“SEC”) and the Department of Justice (“DOJ”).  By November it appeared she had gotten at least part of her wish.  Wells Fargo announced the following in its Form 10-Q filed with the SEC on November 3, 2016: “Federal, state and local government agencies, including the United States Department of Justice and the United States Securities and Exchange Commission, and state attorneys general and prosecutors’ offices, as well as Congressional committees, have undertaken formal or informal inquiries, investigations or examinations arising out of certain sales practices of the Company that were the subject of settlements with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency and the Office of the Los Angeles City Attorney announced by the Company on September 8, 2016.”  Given the changes in leadership at the SEC and the DOJ that will occur with the beginning of the Trump Administration, the timing and outcome of these investigations remains to be seen; however, the bank is also responding other requests for information on the sales practices and circumstances of the original settlement and the bank’s lawyers are busy defending a number of lawsuits have been filed by non-governmental parties seeking damages or other remedies related to these sales practices.  In addition, leaders in several states, including California, Illinois and Ohio, announced that Wells Fargo had been banned from doing business with state agencies in those states, as well as participating in any state bond offerings, and similar bans were announced by leaders in various cities including Chicago and Seattle.

The scandal initially had a devastating impact on investors and others who depend on the value of the bank’s stock, such as low- and mid-level employees, who had received stock options as part of their compensation arrangements.  From early September 2016, when news of the settlement was released, until mid-October 2016 the market value of the bank’s stock fell by almost $28 billion.  When earnings for the third quarter were announced they had slipped to $5.6 billion from $5.8 billion for the same period a year earlier; however, there were signs of even more alarming problems for the future.  For example, in presentations to investors the bank reported that banker and teller “interactions” had dropped from the previous year and from August 2016, the month before news of the scandal broke, and that consumer checking account openings and applications for the bank’s credit cards had also fallen off sharply.  Similar softening of demand was occurring with respect to mortgage referrals from retail branches.

The announcement of results for the fourth quarter included word that new credit card applications were down 43%, new checking account openings had fallen by 40% and both teller transactions and customer interactions with the bankers in the branches had also declined when compared to the fourth quarter of 2015.  The bank’s expense ratio—the bank’s expenses divided by revenue—had climbed outside of its typical range owing in part to the legal bills and advertising expenses associated with dealing with the scandal and attempt to regain the trust of customers.  However, in spite of all this, Wells Fargo stock enjoyed the surge that other banks and financial institutions experienced in the wake of the election results of November 2016 and the share price, which had fallen to $45 in early November, had risen to $55 in mid-January of 2017.

Has the bank weathered the storm?  Macroeconomic conditions looked promising: rising interest rates, robust job market, strong “credit quality” among potential borrowers and the real possibility of reduction of banking regulations.  At the same time, Wells Fargo faced stiff competition from traditional banks and new players in the financial services industry offering innovative products and services without the large expense of maintaining a “brick-and-mortar” infrastructure.  Whatever the future held, it was clear that Wells Fargo had failed several stakeholders: the employees who were fired; the customers who were bilked; the investors who believed in the board and saw the bank’s reputation plummet; and the trust of the communities in which the bank operates.

Commentators have correctly pointed out that the Wells Fargo scandal sheds a harsh light on the shortcomings of the bank’s board of directors in exercising several of its key dues and obligations to the shareholders and other stakeholders of the bank.

The entire board, as well as the committee of the board tasked with focusing on risk management, has a duty to continuously assess risks that are inherent in the company’s business and take prompt action to mitigate those risks before they explode into a crisis like the Wells Fargo situation.  In this case, the evidence seems to be clear that top officials of the bank knew of the practices well before the dates that were originally stated but obviously did little or nothing to address the issue.  In fact, many former employees have come forward with stories about how it was well-known throughout the bank that fraud was going on and that anyone who spoke out would be punished.  Whistleblower systems were failing and while the bank employs a large number of people—over 264,000 as of 2015–certainly terminating 5,000 employees for alleged fraudulent practices would be a systematic problem that should be picked up by the bank’s risk management and governance systems and questioned by board members.

The board, as a whole as well as through the actions of its compensation committee, also has a duty not to enter into compensation arrangements that encourage bad behavior.  Since the board acted fairly quickly to rescind previously approved bonuses and other compensation to senior executives who either knew or should have known about the fake accounts, which bonuses and compensation were originally awarded based in part on the enthusiastic recommendation of Stumpf as the chairperson of the board, it would seem that the board conceded that it failed to do sufficient due diligence in this situation.  Interestingly, the bank’s proxy materials used prior to public disclosure of the scandal indicated that the board understood that compensation practices could create risks for the bank if they rewarded improper behavior and that the human resources committee met each year with the company’s chief risk officer “to review and assess any risks posed by our enterprise incentive compensation programs”.  However, later reports indicated that the risk and human resources committee of the board actually failed to communicate and that the risk committee was likely never briefed on compensation practices and issues.  Eventually, the board did take action to reduce executive compensation in response to the scandals.  In March 2017, it was announced that Sloan and seven other top executives would not receive a cash bonus for 2016 and have their vested equity awards from 2015 cut by up to 50% “based on the accountability of all those in senior management for the overall operational and reputation risk of the company, and not on any findings of improper behavior in the board’s ongoing independent investigation.”  According to bank estimates, the total amount of the compensation cuts was about $32 million.

In addition to their duties with respect to risk management and compensation, directors, especially the independent directors who are not involved in the day-to-day business activities of the company, should continuously monitor the organizational culture of the company, starting at the top with the employee members of the board and then continuing with the other members of the executive team and farther down to the bottom of the organizational hierarchy.  The immediate response of the bank when news of the fraudulent accounts and mass firings emerged was to view it as an issue of employee misconduct, in spite of its being so widespread, and to willfully ignore the possibility that there were serious flaws in the organizational culture and the supervisory chain.  What made the response even more puzzling and troubling was that industry watchers had been characterizing the bank’s culture as aggressive and intense—cross-selling has been a preferred sales strategy for years–long before these sales practices came to light and it apparently it was well known among bank employees that promotions and bonuses came to those who opened as many different types of accounts as possible, regardless of whether customers really needed them, and that employees who could not or would not keep up with the push for new accounts would be punished.

The reaction of the bank’s board to the scandal was also interesting given its composition and apparent experience in bank regulatory and operational issues.  It was reported that the board, which was composed of fifteen members, included top corporate executives, former high-ranking United States government officials, an accounting expert and an academic and was impressively diverse (40% of the members were women and 2/3 of the members were either female, Asian, African-American or Hispanic).  Moreover, two of the members were former financial regulators with extensive experience in consumer banking.  In spite of all of this, and the hefty compensation that board members received ($279,000 to $402,000 in 2015), the board appeared to be clueless about a situation that was bubbling throughout the bank’s extensive branch network in thousands of communities.

The Wells Fargo situation and the apparent ethical missteps of Stumpf as he served as both chairperson of the board and the CEO brought up the continuously discussed question of whether those roles should be separated.  In the past, the bank’s board has argued against separating the roles of the chairperson of the board and the CEO on the grounds that the existing structure was providing effective independent oversight of management and board accountability and that the bank’s strong financial performance was sufficient evidence that its governance structure was working effectively.  Until the scandal came to light, the shareholders apparently agreed and resoundingly rejected insurgent proposals for an independent chairman.  However, one of the notable responses to the scandal was the board’s reversal on this issue and voluntary decision to separate the two positions once Stumpf left.  Stephen W. Sanger, the new chairperson of the board selected by his colleagues, previously served as chief executive and chairman of General Mills and was no newcomer to the situation at the bank.  He had been a director of the bank since 2003 and the “lead independent director” since 2012.  It seems fair to ask, as some critics have done, what he has been doing during all that time to further independent oversight of the senior management team.  If, as some have claimed, he was unable to comprehend the risks that the bank was taken on because the CEO was controlling the information that was provided to the board, then one of his first jobs as the chairperson should be to find out who else was involved in that deception and purge them and then move on to creating a whole new reporting structure that empowers independent directors to fulfill their obligations to shareholders and the other bank stakeholders who have been injured by the scandal.

Sources: G. Morgenson, “Wells Fargo Board, Now in Spotlight, Recalls Its Role”, The New York Times (September 28, 2016), B1; M. Corkery and S. Cowley, “Bank’s Leader Exists Abruptly Amid Scandal”, The New York Times (October 13, 2016), A1; J. Stewart, “Justifiably, This Buck Stopped with the Chief Executive”, The New York Times (October 13, 2016), B3; M. Corkery and S. Cowley, “Shake-up at Wells Fargo Fails to Dispel Skepticism From Lawmakers”, The New York Times (October 14, 2016), B1; K. Sweet, “Wells Fargo earnings fall after scandal”, San Francisco Chronicle (October 15, 2016), B1; K. Pender, “Wells board is also to be blamed for fiasco”, San Francisco Chronicle (October 16, 2016), D1; G. Morgenson, “Wells Fargo Must Make Clean Break”, The New York Times (October 16, 2016), Sunday Business 1; M. Corkery “Wells Fargo Struggling in Wake of Fraud Scandal, Quarterly Data Show”, The New York Times (January 14, 2017), B2.

_____

This article was prepared by Dr. Alan S. Gutterman, the Founding Director of the Sustainable Entrepreneurship Project (seproject.org), and first published on Linked Pulse on March 1, 2017.

 

Profiles of Sustainable Entrepreneurship: Pearl Automation

A recent article in The New York Times discussed Pearl Automation, which was founded in 2014 by three former senior managers from Apple’s iPod and iPhone groups.  While Pearl has maintained what its founders believe to be the best parts of Apple culture, particularly the focus on innovative design and creating products that provide the highest quality user experience, they have also made a conscious decision to reject certain elements of that culture that they found to be counterproductive for engaging employees and creating and maintaining a healthy work environment that allows employees to fill as if they are seen as valued contributors.

The first thing to understand about Pearl is its focus on using technology to improve the safety of the tens of millions of older cars that are being driven without the high tech safety features that are now commonly installed on newer models.  Pearl seeks to develop products that will make the roads safer, a socially responsible goal that proved to be quite appealing to the dozens of former Apple employees who joined Pearl after growing weary of spending their professional lives worrying about incremental improvements to the iPhone and the Mac.  One of the co-founders explained: “Adding safety features to the cars on the road today is a way to make them more useful. We want to help people to modernize their cars without having to buy a new one.”  Indeed this a laudable social objective; however, the number of older cards being used by consumers who are not interested in, or able to, invest in new models makes Pearl’s target market quite large and the opportunity for economic success is apparent.

Open and continuous communication with everyone in the company is an important principle for the founders, something that stands in stark contrast to an Apple culture in which access to information was closely guarded and employees were discouraged from talking with one another about their jobs.  At Pearl, the founders and other managers hold weekly meetings with the entire staff to provide briefings on upcoming products, the financial health of the company and technical problems that have been identified and the solutions that the company is pursuing.  Employees are even given a chance to see and hear presentations that senior managers are making to the board of directors.  The guiding principle behind these practices is that everyone at the company is seen as an important contributor to the company’s success and in order to be effective they need to have as much information as possible.

The founders obviously believe that a culture of openness makes the design practices that have been imported from Apple more effective.  For example, Pearl’s products share the same level of complexity as the ones that employees worked on at Apple and Pearl has followed Apple’s lead by breaking big projects down into smaller tasks that are assigned to small teams.  Each of the team members is charged with completing one or more subtasks necessary for the team to be successful, something that was referred to at Apple as assigning people to be the “directly responsible individual”.  This approach maximizes participation and decentralizes decision making, in sharp contrast to the tight control that Steve Jobs, and now his successors, exerted over the smallest details relating to the work the Pearl employees did at Apple.  Contributing at Pearl means having a say in what problems need to be solved, something that only works if employees have access to full product design picture.

Pearl’s cultural and business competencies also include a disciplined approach to engineering, a passion for elegant and efficient design and an appreciation of the need to vigorously oversee the activities of the dozens of companies in the company’s supply chain.  Rigorous deadlines are set and presumably circulated among everyone in the company at the weekly meetings.  Communication regarding technical issues compliments the company’s focus on relentless investigation of design and operating flaws, a practice that also carries over to negative feedback from customers.  The founders emphasized the importance of understanding why a failure occurred as a means for getting a good grasp on the full boundaries of the problems that must be solved.  Pearl also invests a lot of time and effort in testing, something that the founders believe many startups do not pay enough attention to.

All in all, the early steps that Pearl has taken to develop and implement its business model include a number of important elements for all potential sustainable entrepreneurs to consider:

  • Pearl’s founders selected a business model that emphasizes innovation and proactively targets an important social issue: minimize the risks associated with driving by making cars safer.
  • Pearl’s products are closely related to the actual needs and preferences of potential customers and continuous testing of prototypes ensures that customer feedback is collected and integrated into product design.
  • Borrowing from their experiences at Apple, the founders have established functional excellence as a requirement of Pearl’s sourcing arrangements.
  • The founders have created an organizational culture in which everyone is involved in the development and implementation of sustainability practices and has an opportunity to access information about the business model and contribute to the success of the product development and commercialization process.

However, Pearl also faces several challenges in its path toward sustainable entrepreneurship.  For example, while the size of the potential market for its product seems apparent, the company has yet to demonstrate its ability to execute a production and pricing strategy that ensures the product will be accessible at reasonable prices that still allow the company to enjoy margins that will support survival of the business.  Another consideration is whether making it easier for drivers to keep their older vehicles on the road will slow transition to newer, more environmentally-friendly cars or wider use of mass transit solutions.

Click here to download “Sustainable Entrepreneurship”, which is part of the Project’s Library of Resources on Entrepreneurship for Sustainable Entrepreneurs.