Moral Reasoning and Ethical Climate : Not-for-Profit vs . Holly Henderson Brower For-Profit Boards of Directors

Utilizing Rest’s moral development and Victor and Cullen’s ethical climate surveys, we examine differences in moral reasoning and ethical climate between board members in the for-profit and not-for-profit sectors. Six for-profit corporations and seven not-for-profit corporations, all with base operations in a major midwestern state, participated in the study. We find that profit and not-for-profit boards may not differ in moral reasoning, but do exhibit different types of ethical climates. We also find that for-profit board members may utilize higher stages of reasoning a greater percentage of the time than not-for-profit directors. In contrast, the ethical climates of the two types of organizations are significantly different. For-profit companies had climates higher in egoism than did not-for-profit companies. In addition, not-for-profit firms reflected higher benevolence factors than for-profit firms. Not-forprofit organizations also had somewhat higher, but not significantly different, mean scores on the principle factor compared to the for-profit organizations. This paper will focus on moral reasoning in the boardroom. In particular, in this study we will attempt to determine whether the moral reasoning of boards of directors differs between not-for-profit, voluntary boards and paid directorships in the for-profit sector. Research in the field of business ethics has been done primarily in the accounting and marketing fields, but exceptionally little in the area of management and governance. We seek to empirically explore whether there is a difference in the way board members reason when sitting on for-profit versus not-for-profit boards, and how the culture of the organization interacts with the level of moral reasoning. Although research is lacking in this field of study, it is generally felt that directors of not-forprofit, charitable boards generally behave “more ethically” than corporate for-profit board members (e.g. Machan and Uyl, 1987; Wang and Coffey, 1992). The rationale for this impression involves several factors. Not-for-profit directors volunteer their time to sit on the board of their choice. Because there is no financial remuneration, the motivation for their service may be somewhat more generous and selfless in nature. They must choose to serve on a board of directors because of wanting to give back to the community or wanting to use their skills and talents to serve in an organization that has helped them or someone they love, or to receive some other esoteric reward for their time. In addition, the mission of the not-for-profit organization is often one of service to a community or a specific clientele. Without a money-making motive, acting in the best interests of all “stakeholders” can be more easily defended and is expected. Finally, because not-for-profits generally raise Moral Reasoning and Ethical Climate: Not-for-Profit vs. Holly Henderson Brower For-Profit Boards of Directors Charles B. Shrader Journal of Business Ethics 26: 147–167, 2000. © 2000 Kluwer Academic Publishers. Printed in the Netherlands. Holly H. Brower is a doctoral student at the Krannert School of Management at Purdue University. Her research interests include group decision making, corporate strategy and governance. She was formerly the Graduate Fellow of the Murray Bacon Center for Ethics in Business at Iowa State University. Charles B. Shrader is Departmental Executive Officer of the Department of Management, College of Business at Iowa State University. He was formerly the Director of the Murray Bacon Center for Ethics in Business at Iowa State. His current research interests include the effects of strategy and governance on organizational performance. He is also an active case writer. His publications appear in the Journal of Management, Human Relations, Entrepreneurship: Theory & Practice, Case Research Journal, Journal of Small Business Management, Journal of Managerial Issues, and Journal of Business Strategies. their operating funds (at least in part) from charitable donations and community fund-raisers, there may be a heightened sense of accountability to the community and the clients to act honestly and in their best interest. Boards of directors serve the critical roles of providing control, service, and strategy for the organization (Zahra and Pearce, 1989). There are several theoretical perspectives used to describe the mechanisms and rationale by which directors meet these roles. In their review of these perspectives, Zahra and Pearce (1989) describe the resource dependency perspective as most appropriate for understanding not-for-profit boards. As such, directors are chosen as boundary spanners between the organization and critical community resources such as funders (Shrader, Hoffman and Stearns, 1991). The composition of the board and characteristics of directors are especially critical for the not-for-profit organization. Agency theory is the perspective that has been applied most often to for-profit boards. In this perspective, directors’ primary role is to align the interests of management with those of shareholders. They serve a critical oversight function to protect shareholders from the potential of selfserving management. These different foci – boundary spanning versus oversight – differentiate not-for-profit boards from for-profit boards. In the for-profit domain, theories of organization control are used to explain who has responsibility for the moral implications of business decisions (Monks and Minow, 1989). Agency theory takes the perspective that the principals of the organization are the shareholders and managers, and directors are agents who represent the best interests of the shareholders (Monks and Minow, 1989; Dobson, 1991; Klein, 1991). This theory suggests that for-profit organizations have opposing demands from differing stakeholders such as making the greatest profits in the best interests of shareholders, being a “good community citizen” in localities where the company is represented, being a generous caretaker of employees, and producing and delivering the highest quality product for the customer. These demands are often in conflict with each other and can be used to justify actions that some may criticize as immoral or unethical (Nesteruk and Risser, 1993; Dobson, 1991; Klein, 1991). For example, in an attempt to maximize shareholder interests and profits, a firm may downsize – laying off employees or closing operations in a community. The public outcry often is that the firm is being irresponsible although share price and earnings may rapidly increase as a result. Their responsibility to shareholders is served at the expense of other organizational stakeholders (usually shareholders). Thus, the fundament of agency theory is that authority is delegated to directors and managers by stakeholders to act on their behalf. Stewardship theory, on the other hand, assumes that directors are motivated to act in the best interests of their constituents (Davis, Schoorman and Donaldson, 1997). Given a choice between self-interest and the collective interests of the organization, a steward will not relinquish the goals of the organization. The focus in explaining organizational behavior in stewardship theory is on intrinsic motivation, while agency theory clearly emphasizes extrinsic rewards. With this distinction between agency and stewardship theories, it seems plausible that different types of moral reasoning would characterize board members in different governance settings. The agency cost environment of the for-profit sector should logically lead to predominantly extrinsically motivated reasoning and behaviors. The fact that significant financial compensation is involved in serving on a for-profit board also complicates the incentive for a director to make the most “selfless” or ethical decision. For example, if a CEO hand picks a director and pays her well, a certain loyalty is developed for the director to simply ratify decisions recommended by the CEO. The magnitude of CEO compensation has received vast criticism in the literature and some question the ethics of compensating a CEO so well and in forms which are not associated with performance (Westpal and Zajac, 1995; Beatty and Zajac, 1994; Faulk, 1991; Geneen, 1984; Bavaria 1991). In addition, information about operations at a for-profit company is usually held more closely and is, therefore, not as readily open to the public for scrutiny or approval. As a result of these arguments, we 148 Holly Henderson Brower and Charles B. Shrader