Moral Values in Business Organizations

Understanding how to apply moral values to business organizations requires understanding the institutional context of those organizations. Why do we even have business organizations, and how are they properly constrained? In this chapter, we’ll explore this context and develop a shared framework for articulating the basic structure and functioning of business organizations.

This will help us understand why certain kinds of moral issues are difficult in business contexts and the considerations that need to be raised in addressing them. Looking from the outside in, it may seem mysterious why it is often difficult to be fully honest, or respectful, or socially responsible in business decision-making. We need to learn how to look from the inside out, so that we can appreciate how even well-intentioned people may struggle to make sound ethical decisions in business contexts.

Upon reading the Purdue Pharma case, you were probably struck with a number of “How did we get here?” questions.

How is it that such a small group of people – all members of the Sackler family – wielded so much influence, keeping the Purdue company complicit in the overuse of OxyContin and resulting opioid epidemic?

Taking one step back: Why is it that privately-owned business organizations, such as Purdue Pharma, are entrusted with developing, producing, and selling potentially harmful products?

And how did the government let this happen? What is the proper relationship between state institutions, such as the FDA, and business organizations, and shouldn’t this preclude businesses profiting from causing large amounts of harm, as Purdue did?

These are all good questions, and they all point to foundational issues about the institutional structure and context of business organizations.

Firms and Transactional Costs

Let’s start with how business organizations function in market institutions. The “theory of the firm” explains why it is that markets, in which all transactions are voluntary and self-directed, involve the creation of firms, in which production and sales efforts are hierarchically directed by managers. This explanation points to how firms lower transaction costs.

Transaction costs are the costs associated with carrying out a market transaction, over and above what is exchanged in the transaction. For instance, if you pay someone to mow your lawn, over and above the money you pay them, there are costs deriving from the time it takes to strike a deal with the laborer, from monitoring whether they satisfy the terms of the deal (by fully mowing your lawn by such-and-such time), and from carrying out your end of the bargain (perhaps they insist on getting paid in cash and so you need to gather and hand over the requisite amount of currency).

Lawn-mowing is one thing. The development, production, and sale of technologically advanced products, such as pharmaceuticals, is quite another. Imagine securing all of the labor inputs you’d need for this, one by one, and continuously, as if you were hiring someone to mow your lawn. First, there is the research and development (R&D) phase, which requires the use of extensive scientific expertise. You would need to contract scientists for each step of the R&D process, somehow figuring out in advance what exactly you would need each of them to do, and then monitoring their completion of these tasks. The same goes for the production phase, which could become very complicated as soon as the supply chain exhibits any disruptions. Perhaps you contract five laborers for packaging pharmaceuticals with a certain box “BOX,” but the supply chain disruption requires putting together two separate pieces, “BOXY” and “BOXIER,” into a single box. You would then have to rewrite the contracts for each of the five laborers or else find new laborers. (The original ones only agreed to package using a BOX, after all.)

Look at how the transaction costs are adding up. Writing contracts, doing more research to learn how to write contracts, monitoring whether the terms of the contracts are being satisfied, rewriting contracts … and much more. Wouldn’t it be more efficient – wouldn’t it lower or eliminate these costs – if you could just get the different workers to agree to work for you in a more open-ended way? That is, wouldn’t it be better if they agreed to be directed by you (or managers working on your behalf) to perform whatever labor is needed, when it’s needed?

It would be better, at least from the perspective of efficiency. This is what the centralized decision-making of firms is supposed to do. Employees agree to work under the direction of managers in a relatively open-ended fashion, and managers are charged with directing employees in response to the firm’s needs.

This is not the only function that business organizations fulfill in markets. We can also view markets as drivers of innovation, leading to the creation of better and new products and services. Business organizations play a key role in this by gathering the information and facilitating the extensive learning needed for these innovations, in ways that individuals acting alone as individual market actors cannot.

So why do we even have business organizations, such as Purdue Pharma? They promise to lower transaction costs in the development and production of complicated products and services. And they often are best suited to gather information and facilitate economically valuable forms of learning.

Legal and Moral Constraints

The fact that business organizations have an important role to play in markets doesn’t imply that they always play this role well and adequately support sound decision-making by market actors. This is what seems true in the Purdue Pharma case. They profitably developed and sold OxyContin. But this was morally unacceptable, given the risks of OxyContin they hid and the resulting harms they helped cause.

The market didn’t keep Purdue Pharma from engaging in this wrongdoing. What should have constrained them, then? There are two general options:

• Legal constraints: Standards that are formally instituted and enforced by state institutions.
• Moral constraints: Standards implied by justified moral values. They may or may not be instituted and enforced as law.

Let’s start with legal constraints, as they apply to business organizations. In order to have laws that apply to businesses, they need to be enforceable on businesses. This means that whatever standard the law imposes—for instance, not allowing a certain substance into a river or the air by an urban area—must be something for which the state can monitor compliance (i.e., measuring whether the pollutant is in the water near a factory) and can impose some sort of sanction. For business organizations, sanctions usually take the form of fines, although in more severe cases, business organizations can be dissolved. (But they can’t be thrown in prison!)

It is not always feasible for standards to be instituted as law, because it might be too difficult or costly to monitor and sanction business compliance. For instance, while we might not like it when a business’s managers engage in invasive, micromanaging behaviors, it would be extraordinarily costly and difficult to monitor compliance with a law prohibiting those behaviors. Or consider how limited legal efforts to uproot racial discrimination from the economy are. While we now have robust laws prohibiting racially discriminatory conduct in hiring, firing, compensation, and promotion decisions, this leaves untouched the many subtle, but still impactful, ways that racial bias can creep into workplace interactions. Some of these go under the heading of “microaggressions,” which are seemingly small expressions of bias and prejudice that, when multiplied across interactions, have a serious impact. These examples suggest that there might be some important moral standards that cannot be applied as law to the conduct of business.

What follows from recognizing that some moral standards for business organizations cannot be applied as legal constraints? If the standards cannot be applied as law, then the agents who are responsible for upholding the standards are not state actors. Those responsible will include managers, who make decisions about how businesses are run. We will also need to consider whether consumers, shareholders, and employees have a role to play. This is why for many of the issues we study in this course, we will be speaking about the moral responsibilities of business organizations. This will be a shorthand way of referring to how businesses and the various individuals that exercise influence over them are responsible for upholding moral standards that are not applied as law.

Contemporary Moral Example

We can review all of what we’ve learned in this chapter by considering an ongoing, pressing moral issue for business organizations: the development of new technologies, such as the forms of artificial intelligence found in “Large Language Models (LLMs).”

First, when and why should business organizations be charged with the development of these technologies? Only when doing so lowers transaction costs and enables innovation that couldn’t be achieved through more dispersed market mechanisms.

Second, what legal and moral constraints apply to businesses developing these technologies, and which moral constraints cannot be applied as legal constraints? Perhaps you think that LLM companies are morally required to compensate the writers and artists whose online content is used for training their LLM. Is this a moral requirement that we could feasibly enforce as law? Thinking through the answer to that question will help crystallize your understanding of the basic institutional context of business organizations.