Model Answers

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Answers to Review & Critical Thinking Questions
(1) Define business ethics and describe an ethical situation in which you had to distinguish between right and wrong. Business ethics is a set of principles that should be followed when conducting business. In addition to a firm’s social responsibility, which describes the firm’s responsibility to its community and to the environment, business ethics also include the firm’s responsibility to its customers, employees, and creditors.

An example of an ethical situation coupled with a natural internal conflict is a student taking an exam in a classroom when the instructor has left the room. The opportunity to cheat is now present. The ethical question now enters the mind of the student who must decide right from wrong.

(2) Identify the entities to which firms have a social responsibility. Briefly describe the social responsibility a firm has to each entity. The major areas of social responsibility for a business are: a. Customers - Firms have the responsibility to use ethical sales practices and ensure product-related customer safety. b. Employees - Businesses have a responsibility toward their employees to ensure their workplace safety, proper treatment by other employees, and equal opportunity. Firms should have a written Code of Responsibility and a formal grievance policy. c. Owners (stockholders) and Creditors - The primary goal of a firm is to increase the wealth of the owners. Business decisions then are made with the owners’ interest in mind. Firms are also responsible for meeting their financial obligations to their creditors. Tying compensation to the performance of the firm can result in increased social responsibility to the firm but creates other problems, such as excessive compensation. Firms must also be mindful to truthfully disclose their financial information. d. Environment - With regard to air, water, and land pollution, firms have a responsibility to minimize the impact of their operations on the environment. e. Community - Firms demonstrate their concern for the community by sponsoring local events or donating to local charities. Firms have a responsibility to maintain good relations with their suppliers, government authorities, and others affected by their operations. (3) How can tying employee compensation to a firm’s performance resolve some conflicts of interest? How can tying employee compensation to a firm’s performance create other conflicts of interest? A firm may provide its top managers with some of the firm’s stock as partial compensation. Then, if the managers make decisions that cause a high level of performance, the value of the firm’s stock should increase. Consequently, employees benefit directly when they make decisions that maximize the value of the firm.

Some top managers who receive stock may report artificially high performance levels of the firm in a period when they want to sell their holdings of a firm’s stock. This allows them to sell the stock at a relatively high price. However, rather than improve the firm’s performance, the managers only manipulated the financial reporting to exaggerate the firm’s performance.

(4) Identify the actions a firm can take to ensure that it fulfills its social responsibility to its customers. A firm can ensure responsibility toward its customers by implementing the following steps: a. Establish a code of responsibilities - Firms can establish a code of responsibilities that explains guidelines for quality in producing...
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