questions i need help on

Moral delima

 

Right vs. Right

Right vs Wrong

1. Summarize key information and ideas as you read the articles that pertain to these two situations. (200 words)
2. Identify the approach from the reading you would use to make a decision for the two situations. (100 words)
3. Identify the decision you would make based on the approach. (100 words)
4. Reflect on the implications for you personally and/or professionally of appropriately addressing both right versus right and right versus wrong decisions. (200 words)

Unconventional
Insights for Managing
Stakeholder Trust

S U M M E R 2 0 0 8 V O L . 4 9 N O . 4

R E P R I N T N U M B E R 4 9 4 1 3

Michael Pirson

and Deepak Malhotra

Please note that gray areas reflect artwork that has
been intentionally removed. The substantive content of
the article appears as originally published.

SMR286

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SUMMER 2008 MIT SLOAN MANAGEMENT REVIEW 43

I
nitiatives to build and maintain trust with various stakehold-

ers — customers, employees, suppliers and investors — have

risen to the top of the executive agenda at many organiza-

tions. We continually hear about “tr ansparency”

initiatives, open-door policies and 360-degree evaluations,

customer-retention programs, voluntary product recalls,

initiatives for corporate social responsibility, rethinking of

“customers as partners” and other trust-building moves. But

the problem is that most companies don’t really understand

how to manage stakeholder trust effectively. In fact, our

research suggests that many of the trust-building initiatives and

approaches that organizations invest in may be of questionable

value. Others might actually destroy trust.

One of the reasons managing stakeholder trust is difficult is

because there are many different stakeholder groups, each with

its own particular needs and perspective. That is, trust is multi-

dimensional, and it’s not obvious which dimension executives

need to focus on when dealing with any particular constituency. Consider

the following: An employee might trust his supervisor because he believes

that she expresses genuine concern for his well-being, or because she is a

very competent manager, or for both reasons. In turn, the supervisor might

trust the employee because she perceives that his values are congruent with

hers, or because she can rely on him to get work done efficiently, or for both

reasons. In a different context, the investment community might trust

a company because top executives are perceived as having integrity, or

because they possess superior management skills, or because they have

taken steps to increase transparency, or because of some other reason

entirely. And so on.

So which dimension of trust should companies target? Specifically, what’s

more important for building trust: a reputation for kind-hearted benevolence

or for fair-minded integrity? Which is more critical: managerial proficiency

or technical competence? When does value congruence matter? And are

initiatives aimed at increasing transparency worth the effort?

Unconventional Insights for
Managing Stakeholder Trust

Michael Pirson is a research fellow with the Hauser Center for Nonprofit Organizations at
the John F. Kennedy School of Government, Harvard University and a lecturer at the Harvard
Extension School. Deepak Malhotra is an associate professor of business administration at
the Harvard Business School and the coauthor of Negotiation Genius (Bantam Books, 2007).
Comment on this article or contact the authors at smrfeedback@mit.edu.

Many companies

invest considerable

time and energy

trying to build trust

with customers,

employees, suppliers

and investors. Why are

some of those efforts

doomed to fail?

Michael Pirson

and Deepak Malhotra

M A N A G I N G R E P U T A T I O N

SLOANREVIEW.MIT.EDU

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44 MIT SLOAN MANAGEMENT REVIEW SUMMER 2008 SLOANREVIEW.MIT.EDU

To investigate such issues, we conducted a study of stake-

holder trust in four different organizations. (See “About the

Research,” p. 47.) The research analyzed the relevance (if any) of

various factors (benevolence, integrity, managerial competence,

technical competence, transparency and value congruence) to

different stakeholders (customers, suppliers, employees and

investors). In essence, we asked what matters — and to whom.

Some of the results were unsurprising. Customers, for instance,

stated that a company’s level of technical competence strongly

influences the degree to which they trust the company. Other

findings were unexpected, and a few were even counterintuitive,

leading us to the following key insights: Transparency is over-

rated; integrity is not enough; the right kind of competence

matters; building trust with one group can destroy it with

another; and value congruence matters across the board. (See

“The Truth About Stakeholder Trust.”) A closer look at each

insight provides important lessons for companies trying to build

and sustain trusting relationships with stakeholders.

Transparency Is Overrated
The 2001 collapse of Enron Corp. and a slew of other corporate

scandals in the United States helped usher in an era of general

distrust of big business. Most observers, including many public

policymakers, concluded quickly that a lack of transparency was

the problem. As a consequence, most of the proposed remedies

have focused on increasing the availability of information to stake-

holders who might be vulnerable. Thus, the Sarbanes-Oxley Act

of 2002 requires companies to follow better reporting standards;

the U.S. Securities and Exchange Commission’s Regulation Fair

Disclosure regulates against the selective disclosure of information

to analysts and influential stockholders; and corporate governance

codes call for the publication of executive compensation packages.

These remedies presumably increase transparency, making it

difficult for executives to engage in illicit activities. If this is so,

they serve a very important purpose.

We have found, however, that transparency seems to have little

relevance in terms of building stakeholder trust. That is, whether

M A N A G I N G R E P U T A T I O N

Conventional Wisdom Reality

To increase stakeholder trust,
companies need to make their
operations more transparent.

Transparency actually can diminish trust depending on what is disclosed.
Transparency with respect to executive compensation, for example,
might easily decrease trust if it reveals no apparent link between pay
and performance.

Integrity is crucial for building trust. Integrity is important, but stakeholders who engage with the company on a
regular basis (many employees and customers, for example) must also feel that
the organization cares about their personal well-being. Even well-meaning, ethical
organizations can destroy trust if they are perceived as being fair but callous.

To engender trust, businesses must
continually display competency in
what they do.

Nobody trusts the incompetent, but people don’t all demand the same kind of
know-how. Employees and investors look most for managerial competence,
whereas customers and suppliers are more concerned about technical proficiency.

When trust is compromised, a company
should act quickly to remedy the situa-
tion with the stakeholder group that’s
been affected.

Managers first need to determine who all the relevant stakeholder groups are.
Only then can they deploy a balanced approach to managing trust that takes into
account the various concerns and interests of the different parties. Otherwise, an
organization might find itself exacerbating one problem even as it

solves another.

The desire to identify with the values of
an organization is an important factor
in building trust only for employees,
regular customers and others who have
a close relationship with the company.

Identification (or value congruence) is important for all stakeholders. That is, not
only employees and customers, but also suppliers, investors and stakeholders of all
types are interested in associating with organizations that they can identify with —
and that they perceive match their values.

The Truth About Stakeholder Trust

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SUMMER 2008 MIT SLOAN MANAGEMENT REVIEW 45SLOANREVIEW.MIT.EDU

companies disclose information may have little effect on their

perceived trustworthiness. In fact, of the various factors we stud-

ied, transparency was the only one that did not affect trust for any

stakeholder group. What explains this?

First, consider that forced disclosure might actually reduce the

quality of what is disclosed. Although fair-disclosure procedures

ensure that every investor is provided with the same information

at the same time, there is some evidence that the quality of infor-

mation shared has diminished since Regulation Fair Disclosure

went into effect.1 Some Wall Street observers complain that

companies that used to share sensitive information willingly

(with at least a subset of stakeholders) are now delaying or with-

holding important information. In addition, past research

suggests that career concerns among executives can create

perverse incentives in the face of financial disclosure: Executives

might focus more on managing the visible numbers (the stock

price, market share and so on) than on strategic initiatives that

could improve the long-term survival and profitability prospects

of the company but that are not rewarded in the short run.2

Second, whether information is disclosed might matter less

than what is disclosed. For example, transparency regarding

executive compensation might do little to build trust if it

reveals vast disparities between the pay of people on the front

lines versus those in the corner offices. Fairness perceptions are

crucial to building trust within organizations, and seemingly

oversized executive pay packages make it difficult for employees

to identify with management.3 Especially when there is no

apparent link between executive compensation and perfor-

mance, perceptions of fairness are damaged and trust diminishes.

In such cases, attempts to build trust through transparency can

easily backfire.

Finally, some empirical evidence suggests that disclosure, far

from being a remedy, can in fact exacerbate the problems it is

supposed to fix. In a fascinating experiment inspired by recent

accounting scandals, participants playing the role of “adviser”

had to tell their “clients” that they had a vested stake in overstat-

ing the value of a particular asset. Theoretically, the disclosure of

a potential conflict of interest should result in a more honest

interaction, eventually leading to a more trusting relationship.

But what really happened? Advisers who were required to dis-

close their bias felt more comfortable exaggerating information.

After all, they reasoned, “I already told them I was biased.” Worse

still, clients perceived these advisers as more trustworthy because

they had disclosed their conflict of interest. In other words,

advisers would have been more truthful, and clients would have

been more careful, if there had been no disclosure at all.4

For a real-life example of the disconnect between transpar-

ency and trust, consider Porsche Automobil Holding SE, the

German luxury-car manufacturer. Ever since Deutsche Börse

AG, the German stock exchange, implemented new reporting

standards in 2001, Porsche has refused to submit the required

quarterly reports. The company contends that quarterly num-

bers can be misleading because of its highly cyclical business,

and it has criticized Deutsche Börse for placing more value on

formal rules than on the quality of information disclosed.5 As a

result of its stand, Porsche has been excluded from the mid-cap

index and has faced threats of being delisted, but the company

still refuses to comply and continues to publish only six-month

and full-year results.

The result of the standoff? Following its exclusion from the

mid-cap index in 2001, Porsche share prices plummeted by 40%

in six weeks. But the stock then rebounded, returning to its pre-

exclusion level within four months, and it has steadily advanced

to new heights each year since. Not only do investors continue to

trust the company, but prospective employees do as well: Porsche

remains among the most popular potential employers in Europe.

In one study, graduating engineers placed the company on the

top of their employer wish list.6 Other stakeholders concur. The

general public consistently lists Porsche as one of the most repu-

table businesses in Germany, and customers worldwide have

rewarded the company with continuously rising profits at a time

when many other car manufacturers around the world have seen

their profits decline.7

Integrity Is Not Enough
Not surprisingly, perceptions of honesty and integrity are

crucial to trust for all stakeholders. However, for people who

engage with an organization on a regular basis, integrity is not

enough. These “high-intensity” stakeholders also must perceive

that the organization cares about their well-being. In other

words, benevolence toward the individual, not just good

character and fair dealing, is critical.

Product recalls are a case in point. In 2007 alone, hundreds of

products were recalled for reasons ranging from Salmonella

bacteria in spinach to exploding batteries in computers. Com-

panies that recall defective products early and proactively are

likely to be perceived as having greater integrity than those that

deny or ignore the problem until action is forced on them by

public or governmental pressure. But even some high-integrity

companies that issue voluntary recalls find that they have irrevo-

cably damaged consumer trust, whereas others walk away from

the experience unscathed — or in some cases with enhanced

consumer trust. The difference is in the degree to which a com-

pany is able to signal concern for the well-being of individual

consumers.

Consider what happened to The Coca-Cola Co. in Europe. In

early June 1999, more than 240 people in Belgium and France

reported intestinal problems after drinking Coke, prompting the

Belgian government to ban Coke products for 10 days. Even

though there was no clear evidence that Coke products were the

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46 MIT SLOAN MANAGEMENT REVIEW SUMMER 2008 SLOANREVIEW.MIT.EDU

culprit, the company decided to recall beverages from five Euro-

pean countries, 17 million cases in total, making it the biggest recall

in the company’s history. CEO M. Douglas Ivester publicly stated

that ensuring the quality of its products was Coca-Cola’s highest

priority. “For 113 years our success has been based on the trust that

consumers have in that quality,” he said. “That trust is sacred to

us.”8 Coca-Cola quickly apologized and assumed responsibility,

citing two quality-control issues (impure carbon dioxide and

contaminated wooden pallets) as potential causes. Although it was

later found that Coke products were not responsible for the

reported health problems, the company had proactively demon-

strated benevolence not just in word but also in deed by offering to

cover health care costs for anyone who had been affected by the

incident. Moreover, as a gesture of goodwill, Coca-Cola also

offered free products to each of Belgium’s 4.4 million homes. Less

than two months after the initial incidents, research indicated that

core consumers of Coke products reported the same levels of

intent to purchase as before the crisis had hit.9 Three years later,

sales in Belgium were reportedly better than ever.10

Contrast that with Coca-Cola’s experience in India. In August

2003, a report by the Centre for Science and Environment, a New

Delhi, India-based environmental advocacy group, argued that

Coca-Cola and other producers of soft drinks were selling bever-

ages containing high levels of pesticides. Here, Coke decided to

approach the problem differently. Along with other soft-drink

producers, Coca-Cola quickly refuted CSE’s claims, presented its

own data to the public, accused the CSE of attacking it to further

CSE’s own cause and announced it would sue the organization.

Those actions might have bolstered the public’s perceptions of

Coca-Cola’s integrity, but they displayed a conspicuous lack

of concern for the well-being of individual consumers. The result:

Sales dropped by 30% to 40% in only two weeks, leading to a yearly

sales decline of 15% in 2003 (compared with prior annual growth

rates of 25% to 30%).11 Moreover, even after India’s health

minister had questioned the validity of CSE’s methods12 and

governmental as well as independent research labs had cleared

Coca-Cola of the allegations, the company still paid for a loss of

consumer trust. In 2006, it reported continuously declining sales

volumes and losses that far exceeded the investments made.13

Other companies have also learned the importance of demon-

strating concern for the well-being of customers. In July 2007,

Apple Inc. introduced the iPhone, a much anticipated product,

and priced it at $599. But only two months later — sooner than

anyone had anticipated — the price dropped to $399. People who

had already purchased the product felt mistreated and sent angry

e-mails to the company. In response, CEO Steve Jobs issued an

open letter to Apple customers. He first defended the price cut as

the right strategic move for Apple and justified the decision by

stating that substantive drops in price were standard in the

technology industry — in other words, that Apple had not acted

unethically. But Jobs then acknowledged that Apple needed

“to do a better job taking care of our early iPhone customers. …

Our early customers trusted us, and we must live up to that trust

with our actions in moments like these.” He then offered $100 in

store credit for Apple products to anyone who had purchased the

iPhone at the higher price. In doing so, he helped maintain

a sense of trust among the company’s most ardent fans and

customers.14 Without that gesture of benevolence, Apple might

have faced a huge consumer backlash.

The Right Kind of Competence Matters
Nobody trusts the incompetent, but people don’t all demand

the same kind of know-how. Internal stakeholders, such as

employees and investors, look most for evidence of managerial

competence: executives’ ability to control costs and lead the work

force in the organization’s efforts to be competitive and create

value. External stakeholders, such as customers and suppliers,

typically care less about managerial competence and much more

about technical know-how: the organization’s ability to produce

goods and services of high quality and deal effectively with

supply-chain issues. Even high levels of competence in one area

can’t offset insufficient competence in the other, sometimes

leading to stakeholder distrust and organizational failure.

Delta Air Lines Inc. provides a vivid example. Hailed widely

for its operational excellence, Delta has been credited with the

invention of the hub-and-spoke model for airlines and for

being at the forefront of state-of-the-art technology, including

internal management software, ticket kiosks and online travel

agencies. Delta has also been touted as a pioneer in travel

comforts, being among the first to offer iPod plug-ins and

airline seats that allow passengers to lie flat. Such technical

accomplishments helped Delta gain the trust of its external

stakeholders, especially customers.15

Unfortunately, Delta failed to demonstrate similar levels of

managerial competence. Among its various missteps were a

highly publicized executive compensation scandal that destroyed

trust between management and workers, massive layoffs in 2004

that continued through 2006 and a delay in pursuing cost-cutting

strategies even in the face of rising fuel costs and increased

competition from low-fare carriers.16 Not only did such episodes

of managerial incompetence eventually force the airline to

declare bankruptcy in September 2005 (it later emerged from

bankruptcy and announced its intention to merge with North-

west Airlines), they also severely shook the trust of internal

stakeholders — both employees and investors.

On the other hand, managerial proficiency without technical

competency can be equally damaging. In early 2004, Sprint was

the third largest wireless phone company in the United States,

serving about 20 million customers. Its primary competitors had

each managed to acquire twice as many customers due to a series

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SUMMER 2008 MIT SLOAN MANAGEMENT REVIEW 47SLOANREVIEW.MIT.EDU

of mergers (Cingular Wireless, which acquired AT&T Wireless

Systems, had approximately 46 million customers, and Verizon

Wireless served about 41 million people). Sprint responded by

acquiring Nextel Communications, the fifth largest wireless

phone provider, which had 15 million customers, becoming

Sprint Nextel Corp. Sprint’s management was determined to

boost investor confidence by building market share with a deal

that was expected to create synergies and

reduce costs. Analysts applauded the merger,

and the company’s stock rose by almost 30%

over the next 15 months.

But others weren’t so enthusiastic. Motorola

Inc., one of Nextel’s key suppliers, soon discov-

ered that its proprietary network would be

phased out within two years of the merger in

favor of a system run by Sprint. This reduced

Motorola’s commitment to the relationship,

and the transition was beset with technical

problems.17 In 2006, 300,000 customers can-

celed their service, mostly blaming the poor

quality of the former Nextel network, and

Sprint’s reputation for customer service took a

huge hit.18 In an April 2007 poll by Zogby Inter-

national Inc., Sprint ranked lowest in a customer

service satisfaction rating of all industry players

in the United States. Customer complaints

became so frequent that in an unprecedented

move, Sprint itself decided to terminate at least

1,000 service contracts with people who had

called customer service “too often.”

In the case of Delta, no amount of technical

competence and innovation could have

salvaged the trust lost with employees and

investors due to perceived managerial incom-

petence. With Sprint, a focus on long-term

viability and competitiveness (managerial

competence) did little to offset the distrust of

customers who had suffered from a lack of

technical competence.

Building Trust With One Group Can
Destroy It With Another
Managing trust is a complex process because

stakeholder groups have different needs, and

efforts aimed at solving one trust problem

can exacerbate others. Consider the case of

Deutsche Bundesbahn, the German railway,

which was once a state-owned organization

known for its technical excellence. Customers

trusted its service and reliability so much that

they used the compliment, “You are as punctual as the Deutsche

Bundesbahn.” Unfortunately, though, the organization was not

being run as efficiently as it could be, suffering high operating

losses. In an effort to boost managerial competence, the railway

was privatized as Deutsche Bahn Aktiengesellschaft in 1994.

The result? The organization is now earning substantial profits

and is preparing for an initial public offering. According to

We have studied trust in organizations across four major categories of stakeholders:

customers, employees, suppliers and investors. (Note: We define trust as the psycho-

logical willingness of a party to be vulnerable to the actions of another individual or

organization based on positive expectations regarding the other party’s motivation

and/or behavior.) To aid in our analysis, we developed a framework that differenti-

ated across stakeholder groups along two dimensions. The first measures the

intensity of a relationship, based on length and frequency of interactions. The

second relates to whether a stakeholder is inside or outside the organization.

The two dimensions — intensity and locus — create four archetypes of stake-

holders. (See “Categorization of Stakeholders,” p. 48.) It should be noted that actual

stakeholder groups will not necessarily be perfectly aligned with any of the four

archetypes. For example, a stakeholder’s relationship with an organization can be

of “moderate” intensity (instead of “high” or “low”), and some stakeholders will have

multiple affiliations (for example, as an employee and a customer). As such, the four

quadrants of stakeholders should be viewed more as a general “map” rather than as

a table of four clearly demarcated cells. As an example that approximates the model

case in reality, each stakeholder group in our study can be associated with one of the

archetypes: customers (high-intensity, external), suppliers (low-intensity, external),

employees (high-intensity, internal) or investors (low-intensity, internal).

We investigated trust across the different categories of stakeholders at four

differently structured organizations: a small- to medium-sized manufacturer in

Switzerland, a large logistical company in Germany, a Western European branch of

an international consulting firm and a public university in Switzerland. In particular,

we studied the importance of six factors — integrity, managerial competence,

technical competence, benevolence, transparency and identification (or value

congruence) — to the different stakeholders.

Nearly 1,300 stakeholders — employees, customers, investors and suppliers —

from the four organizations participated in the study. People who reported more

than 100 interactions and more than three years of contact with the organization

were classified as having a high-intensity relationship. Those with fewer than 100

interactions or less than three years of contact were classified as low-intensity

stakeholders. In addition, by definition people were classified as either internal

(employees and investors) or external (customers and suppliers). (Note: Investors

are classified as internal because they are, in effect, owners of the organization.)

From the data, we were able to determine what factors were important to which

stakeholders. (See “What Matters to Whom,” p. 49.) For instance, we found that people

in low-intensity relationships did not base their trust on benevolence (the perceived

concern of the organization toward the stakeholder), but people in high-intensity rela-

tionships did. And integrity was significantly more relevant for people in low-intensity

relationships than in high-intensity ones. Some of the findings were surprising and a

few were even counterintuitive. Those results are discussed in detail in this article.

About the Research

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SLOANREVIEW.MIT.EDU

almost any standard, it is a successfully managed operation. But

there’s a problem: Customer trust has plummeted. Poor service

and constant delays have led to consistently poor reputation

ratings even as profits have increased. The lesson is that unless

a company takes a balanced approach to managing stakeholder

trust, it can find itself exacerbating one problem even as it

solves another.

Consider toymaker Mattel Inc.’s painful saga. In August 2007,

consumers learned that several of Mattel’s toy products were

defective and that others were contaminated with lead paint. In

the following weeks, the company issued three major product

recalls involving more than 20 million items.19 In an effort to

rebuild customer trust, CEO Robert A. Eckert publicly declared

that Mattel itself had been “betrayed” by its Chinese suppliers. He

asserted that these subcontractors had violated the company’s

standards and had used unauthorized lead-based paint. To avoid

future problems, Mattel management promised to implement

a strict system that would include pre- and post-production

controls aimed at suppliers and products.20 In addition, Mattel

terminated its relationship with several suppliers.

The aggressive response might have helped salvage customer

goodwill, but the consequences for trust with other important stake-

holders were devastating. The Chinese government was outraged by

Mattel’s attack on Chinese businesses and institutions, and the

owner of one Chinese toy factory reportedly committed suicide.

Later, after it was found that most of the recalled items (17.4 million)

had nothing to do with lead paint but rather with malfunctioning

magnets, Chinese governmental officials demanded an apology.21

On September 21, Thomas Debrowski, Mattel’s executive vice presi-

dent for worldwide operations, flew to Beijing and publicly issued

the following mea culpa: “Mattel takes full responsibility … and

apologizes personally to you, the Chinese people. … it’s important for

everyone to understand that the vast majority of these products that

we recalled were the result of a flaw in Mattel’s design, not through

a manufacturing flaw by Chinese manufacturers.”22 This time,

Mattel’s strategy was aimed at rebuilding trust with the Chinese

government and the Chinese suppliers, but this too led to its share of

backlash. Sen. Charles Schumer echoed the reaction of consumer

advocates across the United States when he likened Debrowski’s

words to a “bank robber apologizing to his accomplice rather than

the person who was robbed.”

Although trust trade-offs are sometimes unavoidable, they can

often be anticipated and their negative consequences mitigated.

The key is to avoid defining the set of relevant stakeholders too

narrowly. If Mattel had, from the outset, identified the multiple

stakeholder groups that were affected by the recalls — and which

would thus be affected by the company’s response — it might have

taken a more balanced approach that considered the various

concerns and interests of all those parties.

Value Congruence Matters Across the Board
One of the most underestimated determinants of trust is the

desire of stakeholders to identify with the values of an organiza-

tion. Many people believe that value congruence is important

only in relatively few, close relationships, for example, between

spouses, friends or close business partners. But we have found

that although value congruence matters most to employees (that

is, to individuals who are indeed closest to the organization), it is

also an important factor for every other stakeholder group we

studied. In other words, stakeholders of all types are interested in

associating with organizations with whom they can identify —

and with whom they perceive a match in values.

Google Inc. illustrates the critical role that value congruence can

play — both positively and negatively. When Sergey Brin and Larry

Page took Google public in 2004, they created two share classes: Class

A (for outside investors) would have just one-tenth the voting rights

of Class B (for insiders). This sent a signal that Google insiders would

remain in charge and that no outsiders could impose their values.23

48 MIT SLOAN MANAGEMENT REVIEW SUMMER 2008

M A N A G I N G R E P U T A T I O N

Stakeholders can be categorized according to the intensity

of their relationship with the company (based on length

and frequency of interactions) and their locus (that is,

whether they are inside or outside the organization). Those

two dimensions — intensity and locus — can be plotted to

create four archetypes. It should be noted that actual stake-

holder groups will not necessarily be perfectly aligned with

any of the four archetypes. For example, a stakeholder’s

relationship with an organization can be of “moderate”

depth, instead of “high” or “low.” But as a rough simplifica-

tion that approximates the modal case in reality, the major

categories of stakeholders — customers, suppliers, employ-

ees and investors — can be loosely associated with one of

the archetypes.

Categorization of Stakeholders

Locus

Intensity

External

Internal

Low High

Investors Employees

Suppliers Customers

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SUMMER 2008 MIT SLOAN MANAGEMENT REVIEW 49SLOANREVIEW.MIT.EDU

“[We] intend to operate Google differently, applying the values it has

developed as a private company to its future as a public company,”

Page explained. “We will live up to our ‘don’t be evil’ principle by

keeping user trust and not accepting payment for search results. …

[We] will do our best to make Google a long-term success and the

world a better place.”24 Various stakeholders embraced Google’s

values, which engendered high levels of trust. The company was

named the best place to work;25 in several surveys it received stellar

marks for its reputation;26 and its stock price soared.

Recently, however, Google has come under fire, and a big

source of the problem appears to be the company’s espoused

values. In order to serve the Chinese market, Google made a deal

with the government there to accept self-censorship for certain

topic areas, such as the Tiananmen Square massacre, Tibet and

the independence of Taiwan. Although competitors Microsoft

Corp. and Yahoo! Inc. had made similar concessions, Google’s

actions were seen as particularly reprehensible by many users

because of the company’s values pledge (“don’t be evil”).27 As a

consequence, people’s trust was severely shaken. Google execu-

tives were compared to Nazi collaborators and had to appear in

Congressional hearings to explain their actions. Protestors

marched at the company’s headquarters in Mountain View,

California.28 Later, Sergey Brin would admit that, “on a business

level, that decision to censor … was a net negative.”29

The online classified service craigslist inc. is another organiza-

tion that views value congruence as a core company asset. Founder

Craig Newmark is more likely to reference “the golden rule” than

“the profit motive” when discussing appropriate guides for iden-

tifying and achieving organizational objectives, and CEO Jim

Buckmaster has told investment bankers and Wall Street analysts

that monetizing its services and finding additional revenue

sources in an effort to maximize profits is “not part of the goal.”30

This approach appeals to craigslist’s customer base and employ-

ees. (Our own data suggests that many stakeholders mistrust

businesses in part because companies have a fiduciary responsi-

bility — and usually strong incentives — to maximize shareholder

value, and their behavior is hence perceived as opportunistic.31)

But, of course, investors have a different perspective altogether.

How might companies deal with this dilemma?

On the one hand, craigslist has been growing at a remarkable

rate and its expected market value (were it to issue an IPO)

continues to increase even as it clings to the values it espoused at

its founding. This suggests that a company can be values-driven

without necessarily incurring a penalty in its market value.

Furthermore, the success of “socially conscious funds”32 suggests

that the conflict between investor values and the values of other

stakeholders might be diminishing. On the other hand, unless

a business is privately held (which craigslist is), it will likely

encounter great difficulty if it continually resolves trust trade-offs

by giving short shrift to investors. Rather, a more effective long-

term approach might favor values-congruent operations and

objectives within the constraints of fiduciary responsibility.

Research has shown that, despite their fiduciary duty to maxi-

mize shareholder value, managers have much more latitude in

managing social responsibility than is often assumed. Moreover,

a meta-analysis of past studies has found that the effect of corpo-

rate social responsibility on financial performance is small but

positive.33 In other words, companies can appease a diverse set of

stakeholders (at least to a degree) without offending investors.

Unfortunately, businesses seem to be doing poorly in terms of

perceived value congruence and trust, and the overall reputation of

corporations in the United States (and throughout the world) leaves

much to be desired. In 2005, 71% of respondents in an annual

survey rated the reputation of U.S. businesses as “not good” or “ter-

rible.”34 Global businesses, meanwhile, were awarded negative trust

ratings by a majority of respondents in more than 14 countries

surveyed by the World Economic Forum in 2006.35 This is certainly

bad news for businesses as a whole. But it also suggests an

Different stakeholder groups do not place the same impor-

tance on the different factors of trust studied: integrity,

managerial competence, technical competence, benevo-

lence, transparency and identification (or value congruence).

For example, people in low-intensity relationships with a com-

pany do not base their trust on benevolence, whereas people

in high-intensity relationships do.

What Matters to Whom

Identification

Managerial
Competence

Technical
Competence

Benevolence

Integrity

Identification
Managerial
Competence
Technical
Competence
Benevolence
Integrity
Identification
Managerial
Competence
Technical
Competence
Integrity
Identification
Managerial
Competence
Technical
Competence
Integrity
Locus
Intensity
External
Internal
Low High

Indicates that a specific trust element matters relatively more
in this type of relationship than in another type of relationship.

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50 MIT SLOAN MANAGEMENT REVIEW SUMMER 2008 SLOANREVIEW.MIT.EDU

opportunity to build trust and leverage it as a core asset for any

company that can successfully balance fiduciary responsibility with

a strong emphasis on stakeholder value congruence.

STAKEHOLDERS DIFFER WITH REGARDS to the kinds and degrees of

vulnerability they face. What they need to believe before they will

trust a company also differs. Managers need to consider those

varying needs and anticipate the trade-offs that exist in strength-

ening relationships with employees, customers, suppliers,

investors and others. In short, companies can’t take a one-size-

fits-all approach to managing stakeholder trust. Nor can they

simply leverage conventional wisdom.

Our work provides an initial step toward building a stakeholder-

specific model of organizational trust. The framework challenges

some existing beliefs and sheds light on a number of areas that

companies would be wise not to ignore. In particular, our results

suggest that managers need to better understand the seemingly

expansive role of value congruence and identification, more fully

consider the contexts in which integrity without benevolence is

a recipe for distrust, more carefully investigate the distinction

between managerial and technical competence, and more rigor-

ously evaluate the costs and benefits of transparency initiatives.

Deeper knowledge in these and other areas will help companies

become more adept at managing stakeholder trust so that they

might reap the numerous benefits, including improved coopera-

tion with suppliers, increased motivation and productivity among

employees, enhanced loyalty from customers and higher levels of

support from investors.

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1. J. Weber, “Commentary: Give ‘Fair Disclosure’ Time to Work,” Busi-
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2. See, for example, A. Brandenburger and B. Polak, “When Managers
Cover Their Posteriors: Making the Decisions the Market Wants to See,”
RAND Journal of Economics 27, no. 3 (autumn 1996): 523-541.

3. W. George, “Bill George: Nonperforming CEOs,” Sept. 6, 2007, www.
businessweek.com.

4. D.M. Cain, G. Loewenstein and D.A. Moore, “The Dirt On Coming
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5. “Porsche Faces Delisting From Index as Deutsche Boerse Readies
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6. “Porsche Is Highly Regarded By Students in Europe,” July 30, 2007,
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7. “Porsche Tops Quality Survey,” June 8, 2006, http://money.cnn.com;
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9. V. Johnson and S.C. Peppas, “Crisis Management in Belgium: The
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10. S. Leith, “Three Years After Recall, Coca-Cola Sales in Belgium Are
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11. J. Kaye and P. Argenti, “Coca-Cola India,” Tuck School of Business
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12. “India: Behind the Scare Over Pesticides in Pepsi and Coke,” Busi-
ness Week, Sept. 4, 2006.

13. I. Basu, “Coke Still Floundering in India,” Asia Times, June 23, 2006.

14. J. Pine and J. Gilmore, “Apple’s ‘Phony’ Reaction to iPhone Custom-
ers,” Sept. 10, 2007, http://conversationstarter.hbsp.com; and J.
Martellaro, “iPhone Pricing: No Conspiracy, Rather Nimble Reactions,”
Sept.14, 2007, www.ipodobserver.com.

15. P. Williams and J. Williams, “Why Good Companies Go ‘Bad’ —
By Trying to Be Somebody They’re Not,” www.ravenwerks.com.

16. Williams and Williams, “Good Companies.”

17. J.E. Lappin, “The Unmaking of Motorola,” Jan. 25, 2007, www.forbes.com.

18. C. Oster, “The Customer Service Hall of Shame,” April 26, 2007,
http://moneycentral.msn.com.

19. P.B. Kavilanz, “U.S. Biz Blamed for Dangerous Chinese Products,”
Aug. 2, 2007, http://money.cnn.com.

20. “Mattel Recalls 18.2 Million Chinese-Made Toys,” Aug. 14, 2007,
www.ctv.ca.

21. C. Chandler, “Why Mattel’s ‘Apology’ to China Only Makes It Worse,”
Sept. 25, 2007, http://chasingthedragon.blogs.fortune.cnn.com.

22. “Mattel Sorry for ‘Design Flaws,’” Sept. 21, 2007, http://news.bbc.co.uk.
23. M. Lewis, “The Irresponsible Investor,” New York Times Magazine,
June 6, 2004.

24. L. Page and S. Brin, “Letter From the Founders,” Aug. 18, 2004,
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25. “100 Best Companies to Work for: 2007,” Fortune, Jan. 22, 2007.

26. “How Boss’s Deeds Buff Firm’s Reputation,” Wall Street Journal,
Jan. 31, 2007; and R. Alsop, “Ranking Corporate Reputations — Tech
Companies Score High in Yearly Survey As Google Makes Its Debut in
Third Place,” Wall Street Journal, Dec. 6, 2005, p. B1.

27. “Don’t Be Evil: Restoring the Public Trust in Business, Politics and
the Media,” June 6, 2006, www.dontbeevil.com.

28. C. Thompson, “Google’s China Problem (and China’s Google
Problem),” New York Times Magazine, April 23, 2006.

29. J. Martinson, “China Censorship Damaged Us, Google Founders
Admit,” Guardian, Jan. 27, 2007.

30. “Craigslist Meets the Capitalists,” Dec. 8, 2006, http://dealbook.
blogs.nytimes.com.

31. M. Pirson, “Facing the Trust Gap: Measuring and Managing Stake-
holder Trust” (Ph.D. diss., University of St. Gallen, 2007), www.unisg.
ch/www/edis.nsf/.

32. S. Asci, “Socially Conscious Fund Firms Spread Their Asset-Class
Wings,” Investment News, Dec. 10, 2007.

33. J. Margolis and J.P. Walsh, “Misery Loves Companies: Rethinking
Social Initiatives By Business,” Administrative Science Quarterly 48, no.
2 (June 2003): 268-305.

34. Alsop, “Ranking Corporate Reputations.”

35. B. Coursey, “Trust Trends: Confidence in NGOs On the Rise,” Feb.
13, 2006, www.ethicalcorp.com.

Reprint 49413.
Copyright © Massachusetts Institute of Technology, 2008. All rights reserved.

M A N A G I N G R E P U T A T I O N
For the exclusive use of S. FINCH
This document is authorized for use only by Sharon Finch in GB590 Ethics in Business and Society taught by
Kaplan University from March 2012 to June 2017.

www.sloanreview.mit.edu

www.businessweek.com

www.cfo.com

www.automotoportal.com

http://news.bbc.co.uk

www.ethicalcorp.com

www.unisg.ch/www/edis.nsf/

http://dealbook.blogs.nytimes.com

www.dontbeevil.com

http://news.bbc.co.uk

www.ctv.ca

http://money.cnn.com

http://moneycentral.msn.com

www.forbes.com

www.ravenwerks.com

www.ipodobserver.com

http://conversationstarter.hbsp.com

http://chasingthedragon.blogs.fortune.cnn.com

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Leadership in the Age
of Transparency

by Christopher Meyer and Julia Kirby

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Included with this full-text

Harvard Business Review

article:

Idea in Brief—the core idea

1

Article Summary

2

The Big Idea:

Leadership in the Age of Transparency

Companies have long

prospered by ignoring what

economists call “externalities.”

Now they must learn to

embrace them.

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Idea in Brief

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The big idea:

The key to becoming a con-
temporary corporate leader is to take on re-
sponsibility for externalities—what econo-
mists call the impacts you have on the
world (like pollution) for which you are not
called to account.

The argument: Thanks to trends in three
areas—the growing scale of companies
and their impacts, improvements in sensors
that measure impacts, and heightened sen-
sibilities of stakeholders—the demands to
operate responsibly are dramatically in-
creasing. The stark difference between the
tobacco industry’s irresponsible refusal in
the 1980s to acknowledge lung cancer risks
and the food industry’s swift actions two
decades later to remove trans fats from
products comes down to a willingness to
internalize externalities.

A better approach: An externalities frame-
work allows you to respond rationally and
in ways that are simultaneously defensible
to all stakeholders. By focusing on your
company’s own footprint—societal prob-
lems that really can be laid at your door-
step—you can establish priorities, set mea-
surable goals, and take action.

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H E B

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Leadership in the Age
of Transparency

by Christopher Meyer and Julia Kirby

harvard business review • april 2010 page 2

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Companies have long prospered by ignoring what economists call

“externalities.” Now they must learn to embrace them.

Rarely do before-and-after business cases
present such a neat study in contrasts. Com-
pare the recent actions of the key players in
the food industry with those of the tobacco in-
dustry two decades earlier.

In the 1980s, executives at Philip Morris
were still fighting energetically to hold back
the tide of evidence that cigarettes cause lung
cancer, and claiming that customers were exer-
cising free will in choosing to smoke. A 1993
Washington Post article titled “Scientists Testify
Tobacco Company Suppressed Addiction Stud-
ies” tells the tale: Damning company-spon-
sored research had been spiked a decade be-
fore by senior executives.

Fast-forward to the turn of the millennium
and you see a very different kind of behavior in
the packaged food and restaurant industries. As
the dangers of trans fats came to light, manag-
ers in the most powerful firms took the health
implications to heart and responded quickly, be-
fore the issue became a cause célèbre, by chang-
ing recipes, funding public education cam-
paigns, and pushing reduced-fat products. By

2005, a trade publication was already announc-
ing “Kraft completes trans fat reformulation,”
and every one of the company’s competitors
was following suit. Given that the first U.S. state
law outlawing trans fats in restaurants went into
effect only this year, these were voluntary
changes taken well in advance of legal or regula-
tory compulsion—or even public anger.

What transpired over those 20 years to drive
such divergent managerial responses? Some-
thing very big, actually: As the impacts of busi-
ness on the environment, on society, and on in-
dividuals became too substantial to ignore in
many realms, and cheaper and easier ways to
measure those impacts were devised, the rules
of doing business shifted. Considerations that
hadn’t previously complicated the plans of cor-
porate leaders started getting factored in. In
other words, it was no longer possible to ig-
nore externalities.

Externalities is the term economists use
when they talk about the side effects—or in
the positive case, the spillover effects—of a
business’s operations. They’re the impacts that

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harvard business review • april 2010 page 3

a business has on its broader milieu, either di-
rectly or indirectly, but is not obliged to pay for
or otherwise take into account in its decision
making. The classic example is pollution: A
smokestack in Akron may send particulates
into the air that descend on farmlands down-
wind, but in the absence of any measurement
of those, the factory isn’t charged for ensuing
crop damage. Those effects are out of scope,
and the company is off the hook. How a con-
sumer disposes of your product at the end of
its useful life is another form of externality,
and so is the noise of your factory whistle.

The concept of externalities goes beyond im-
pacts on the physical environment. Say your
menu-driven phone system keeps callers on the
line a bit longer and eats up their minutes, or
your subcontractor decides to cut costs by using
undocumented workers, or property values near
your facilities start to slide: Those are impacts for
which you will likely not be called to account.

When Kraft, Nabisco, and Nestlé decided to
reformulate their recipes, and national restau-
rant chains such as Wendy’s and Burger King
switched to less artery-choking fats in their fry-
o-laters, they were choosing to internalize an
externality. They were taking ownership of an
issue that they could, by law, have continued to
say was not their problem. Yes, they did so
under some activist pressure, and yes, they
could still do more. But unlike tobacco compa-
nies in the 1980s, the food companies didn’t
wait for regulation or lawsuits. They acted.
That’s a big change, and what’s behind it isn’t
as simple as good public relations. There’s
something more nuanced, and at the same
time more hardheaded, going on.

In this article, we’ll explore the forces behind
what we see as a coming sea change in corpo-
rate leadership. We’ll make the case that the
true measure of corporate responsibility—and
the key to a business’s playing its proper role in
society—is the willing, constant internalization
of externalities. Today, business leaders are
bombarded with messages through many
channels that they owe more to society, and
many think so themselves. But often the result
is an incoherent mishmash of charitable giv-
ing, CSR programs, and “going green” initia-
tives. Here, we present a far more disciplined
way to respond to the challenge.

Feedback Forces the Issue

Before we go on, let’s disinvite the elephant

from the room: We have no political agenda,
and certainly no antibusiness agenda, about
the environment, health, or any other social
concern. We’ll talk about these issues, of
course, because externalities so often affect
them, but our perspective has something to
offer both Right and Left. On the Right, we
propose taking responsibility for one’s actions
and employing markets to determine the price
of an impact. On the Left, our approach leads
to greater resources applied to social prob-
lems, with costs borne by those who cause
them. And for both, we offer a framework for
improving the chances of constructive dia-
logue between opposing advocates.

The first thing we can all agree on is that
greater accountability for corporate impact is
unavoidable. Think about what’s involved in an
externality: One party takes action that has ef-
fects on others who did not have a say in the
matter. How long can that persist before feed-
back starts impinging on the actor? Indefinitely,
if the effect is too small to notice, or if the effect
is noticeable but is difficult to trace to a cause,
or if the affected party doesn’t make any objec-
tion. With every passing year, however, each of
those “ifs” becomes more unlikely.

Scale. To begin with, many types of exter-
nality that used to be minor have grown too
large to ignore. When the Eureka Iron Works,
the first Bessemer steel mill, opened in 1854 in
Wyandotte, Michigan, it probably wasn’t very
clean. But however inefficient it was, a single
furnace wasn’t going to have much effect on
the earth’s atmosphere. When the world can
produce on the order of a billion tons of steel
per year, though, the impact becomes promi-
nent. One recent analysis shows that before
1850, global carbon emissions from fossil fuels
were negligible, but by 1925 the figure had
reached a billion metric tons per year. By 1950,
the amount had doubled. By 2005, it had dou-
bled twice more, to 8 billion. Simply put, com-
mercial activity has achieved planetary scale.
The rapid growth of emerging economies will
only accelerate the trend.

Scale has changed not only for industry col-
lectively but for companies individually. Given
the gargantuan size of many of today’s multi-
nationals, even the smallest decisions, or non-
decisions, add up. UPS recently decided to stop
printing paper labels and sticking them to
packages; instead it designed a device to stamp
shipping information directly on boxes. That

Christopher Meyer

is the founder of
Monitor Talent. He is the coauthor of
three books with Stan Davis, including

It’s Alive: The Coming Convergence of
Information, Biology, and Business
(Crown Business, 2003). Julia Kirby is
an editor at large at Harvard Business
Review Group.

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Leadership in the Age of Transparency

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harvard business review • april 2010 page 4

will that save at least 1,338 tons of paper per
year.

Larger corporate scale gives a company a
greater proportion of the responsibility for a
negative externality, and more leverage to cre-
ate a positive one. Hewlett-Packard is not the
world’s largest company, but it recognizes that
its annual procurement budget of $50 billion
gives it an undeniable ability to influence ven-
dors. Rather than using its muscle only to
strong-arm them into price reductions, HP cre-
ated its Supplier Code of Conduct in 2002 to
ensure that suppliers were doing business in a
socially and environmentally responsible man-
ner. To take another example, we all know that
what Wal-Mart wants from suppliers, Wal-
Mart gets. And Wal-Mart knows that at the vol-
ume its stores sell, a shift to, say, recyclable
packaging will be meaningful. It’s now asking
consumer goods manufacturers to report on
the sustainability of their products, including
packaging, and is educating consumers about
the externalities.

Sensors. If the 1900s were, as sociologist
Theodore Caplow says, the “first measured
century,” then efforts to collect comparative
data have only gained momentum since. The
United States AQS (Air Quality System) now
stores data from more than 5,000 active moni-
tors on 188 pollutants—and anyone can regis-
ter to use these EPA data, free. Wireless
nanosensors (“smart dust”) have been tested
on the Golden Gate Bridge to detect vibration
that would signal dangerous wear and tear.

Ubiquitous technical measurement is only
the most obvious improvement in sensing: In-
creasingly, human behavior is tracked as well.
Not long ago, political contributions by indi-
viduals were cloaked in obscurity. Now they’re
published online for all to ponder. When some
newsworthy event happens—like a plane land-
ing in the Hudson—we get waves of data from
surveillance cameras and bystanders’ cell
phone photos.

With growing access to expanding sources of
data comes the ability to see patterns. Consider
Google Flu Trends. Based on the incidence of
Google searches about flu symptoms, it tracks
the course of an epidemic reliably, and two
weeks ahead of the CDC. Or consider City-
Sense, a Blackberry and iPhone app that tells
pub crawlers, based on the locations of those
mobile devices, which establishment is offering
the liveliest nightlife—in real time.

We’re even gaining the ability to “fuse” di-
verse data to see such patterns. Sitting in a
coffee shop, you are simultaneously “seen” by
the GPS system on your phone, the credit
card validation track of your purchase, the IP
address of your computer, the record of your
subway card swipe at the nearest station, and
the shop’s security camera. A friend at one of
the credit-checking bureaus tells us that on
the basis of data available to him he can see a
couple’s divorce brewing six months prior to a
filing.

Not all of this newly cheap and accessible
data has to do with externalities. The point is
that if you are a party disgruntled by some-
thing—anything—the chances of your laying
your hands on relevant information have gone
way up. Thinking again of the Eureka Iron
Works, it wasn’t feasible a century ago to mea-
sure its contribution of sulfur dioxide in the at-
mosphere. Now we can, and do, measure parts
per billion of many pollutants, and much of
this kind of data is accessible anywhere in the
world.

Sensibilities. Suppose you were concerned
about poor air quality in your neighborhood,
and you wanted to find out who was causing it.
In 1950, how would you have done that? We’ll
leave that as a rhetorical question, but today, a
good place to start is with Scorecard.org. We
tried it—it took us 15 seconds to discover the
20 largest polluters in our area. We could also
check how each ranked relative to its industry.
The next step was right there for us, too: We
could click on “Take Action” and then select
from a roster of options, from sending a fax to
the company’s management to joining an on-
line discussion. The fact is, more people do
take action these days, and not only in protest
of corporate wrongs.

The effect of instantaneous communications
has been a rising sense of global connectedness
and responsibility. Natural disasters, when
they happened in other nations, used to elicit
sympathetic noises from a vaguely aware pub-
lic, which was content to know its government
was sending emergency aid. Today, a calamity
like the earthquake in Haiti occurs, and the in-
dividual contributions to organizations such as
the American Red Cross—$4 million worth via
mobile phone texting alone within the first 24
hours—overwhelm their ability to process
them. Even absent catastrophe, the impulse to
reach out is strong; thus the proliferation of re-

Taking Time

The story goes that after testing a new
Mac model, Steve Jobs took his engi-
neers to task because the start-up
time was now longer. He pointed out
that Apple hoped to sell at least a mil-
lion of the new machines, which
meant that a million people would
boot up every day. Every second
added to the process by bloated
code would cost society over 4,000
man-days per year.

It didn’t occur to the group of engi-
neers, properly focused on system
performance, to take that consider-
ation into account. It was an external-
ity. By shining a light on a valuable
resource that his company was failing
to factor into its decision making, Jobs
internalized it.

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tailers offering customers a chance to make a
donation to a cause at checkout—$5 for food
for the poor at Whole Foods, $4 to give a book
to an urban child at Borders, a dollar for the
nonprofit of the day via eBay’s PayPal.

Given the evolving sensibilities of ordinary
people, any apparent callousness by corpora-
tions is more likely to raise hackles. Royal
Dutch Shell was an early target of activist dis-
satisfaction when a range of groups railed
against its environmental and human rights
impacts in the 1990s. By all accounts its man-
agement was blindsided by the change in
mood. The company pioneered a process for
engaging stakeholders, many of whom were
on the attack, to gain an appreciation of their
expectations. Since then, firms of every kind
have experienced similar pressures. Before the
turn of the millennium, few coffee drinkers
paused to think about the struggling farmers
who had harvested the beans. Now, thousands
of consumers are sufficiently concerned to boy-
cott a coffee seller that turns a blind eye (as
Starbucks discovered), and millions more are
willing to pay more for beans with a Fair Trade
seal of approval.

The developments we are seeing in scale, sen-
sors, and sensibilities all fuel one another. The
average company feels the effects because as
measurement improves and access to those mea-
surements becomes ubiquitous, people act on
the information, thanks to heightened sensibili-

ties. Formerly unseen and unremarked effects of
doing business start getting measured, and af-
fected people, armed with data, seek recourse.

The Fog of CSR

What constitutes a “responsible corporation”
in an era of advanced scale, sensors, and sensi-
bilities? We would submit that it is as simple as
this: Stakeholders regard a company as re-
sponsible when they perceive that it is steadily
internalizing externalities—that is, using sens-
ing capabilities to measure and manage its im-
pacts on society. Conversely, when the public
perceives that a company is producing an ex-
ternality that it could take greater responsibil-
ity for but isn’t, that’s when mechanisms of
compulsion are brought to bear, from regula-
tion to riots.

This is an important point: When the costs
of externalities become sufficiently clear—and
onerous—they manage to get internalized in
one way or another. The scope of impact you
are responsible for managing can only con-
tinue to grow. Your choice in the matter is
whether to take charge of that scope or have it
thrust upon you. In terms of corporate reputa-
tion, that makes the choice easy, because the
worst of all worlds is to be made responsible,
and still not be considered responsible.

We’re convinced that the vast majority of ex-
ecutives want their companies to do right by so-
ciety. The fact that they so often act to the con-
trary (resisting beneficial regulation, for
example, or exploiting legal loopholes) is in part
due to the huge assortment of demands made
of them. The pressures come from all directions,
and it often seems impossible to do enough. Pat
Tiernan, Hewlett-Packard’s vice president of cor-
porate social and environmental responsibility,
described the effect of all this on his company:
“Nongovernmental organizations, social re-
sponsibility investment fund interests, and the
media continually demand responses from us.”
Lynette McIntire, who holds an equivalent role
at UPS, told us her organization filled out more
than 130 sustainability-focused surveys in 2009
alone.

The response is often as disorganized as the
demands. Companies engage in an incoherent
jumble of activities under the banners of cor-
porate social responsibility, sustainability, giv-
ing back, going green, and philanthropy. If
your executive team is like most, you need a
way to sort all this out, and an externalities

Ripples of Responsibility

A simple framework can help you come to terms with your company’s externalities.
Start by drawing four concentric circles: The core is the business you manage today;
the rings beyond are impacts on the world for which you haven’t had to account.

Core: Your Business Today

Take Ownership

These are impacts that can be directly traced to your operations. It’s now possible to
measure and manage them, and the world should accept no less.

Take Action

These are impacts that you contribute to and in relation to which you have particular
problem-solving competence.

Take Interest

These are distant ripple effects, and you have no special competence to ameliorate
them. You’ll channel your efforts through other trusted parties.

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framework can help. By focusing on your com-
pany’s own footprint—the problems of the
world that really can be laid at your door-
step—you can establish priorities, set measur-
able goals, and take actions that are defensible
to all stakeholders as proper and coherent.
Among these stakeholders are, of course, your
own people, who long for a sense of confidence
that their organization is wielding its consider-
able power for the good.

A positive angle. It’s important to pause
here and note that while the world tends to
focus on negative externalities, positive exter-
nalities also exist. These are the spillover ef-
fects that others in your system enjoy as a re-
sult of your operations. As the simplest
example, if your company employs a security
guard to keep watch over your building en-
trance, that uniformed presence wards off
threats to the neighbors as well. On a larger
scale, when Google traced the source of an in-
formation security breach recently, the benefi-
ciaries of its fingering the hacker included at
least 30 other U.S. firms. Those who adopt an
externalities framework should therefore bear
this in mind: There’s goodwill to be gained by
producing positive externalities as well as by
diminishing negative ones.

Own Your Impact

To think about how to embrace externalities,

we find it useful to start by drawing four con-
centric circles. (See the exhibit “Ripples of Re-
sponsibility.”) At the center of this simple dia-
gram is the business you run today: the
domain that you actively manage and the key
performance indicators you track. Beyond this
core, every impact you make is something you
consider today to be an externality. The differ-
ences from ring to ring have to do with three
variables: your accountability, your compe-
tence to remediate, and your brand’s reso-
nance with the issue.

Your company’s investments of resources
and attention in solving a problem should cor-
relate with these bands. If a problem is directly
attributable to you (like emissions levels), it
falls within your first ring and the onus will be
on you, not some other company or organiza-
tion, to make up for it. In this ring, all three
variables are in play. The impact is one you can
be held accountable for; you have organiza-
tional competence to address it; and people see
a connection between your business and the
work to be done. If a problem is one you con-
tribute to, but to which your direct account-
ability can’t be measured (be it a collective
problem or a knock-on effect), it is in the sec-
ond ring. You need not take ownership of it,
but given your competence and its relevance,
you should take action. The third ring consists
of more distant ripple effects, in which you

Resetting Your Boundaries

Once you embrace externalities as an organizing principle for your efforts to become and be perceived as a responsible business, how do you de-
cide what to start measuring and what feedback to respond to? If you were going to devote a session at an offsite to deciding what externality to let
in, you might begin by asking everyone present to think expansively about the system in which your offering is situated. You make cars, for exam-
ple, but they operate in a system that includes service, emissions, and traffic congestion. Then, you might provoke ideas by asking the following
questions:

1. Scale

Where do public costs start to come in, and
how does your product contribute to them?

What resources do you buy in large quanti-
ties? Of which are you a dominant buyer?

Is there a resource you are taking for granted?

How do people use your product, and how do
they dispose of it?

When people you’re socializing with learn
where you work, what issue do they bring up?

2. Sensors

What feedback is available that you haven’t
paid much attention to?

What feedback are you busily resisting?

What are the unmeasured costs associated
with your key resources?

What is now possible to measure that wasn’t
before?

What is something you are already measuring
but not factoring into decisions?

3. Sensibilities

How have stakeholders’ expectations
changed?

What part of your system does no one want in
their backyard?

What lawsuits might you be threatened with,
even where you’re on solid legal ground?
What new precedent might a plaintiff hope to
set?

What issue might you embrace if you wanted
to wrongfoot your antagonists?

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should at least take an interest—and a visible
one. You do not have particular competence
on this front, but relevance still applies. This di-
agram, once completed (perhaps via the exer-
cise we describe in the sidebar, “Resetting Your
Boundaries”), serves as a guide to becoming a
truly responsible company.

Taking ownership. The first priority, corre-
sponding to the first ring of our model, is sim-
ply to bring into your managerial scope all the
“side effects” of your operations that should no
longer be called externalities because they are
known or knowable. Peter Drucker wrote, “One
is responsible for one’s impacts, whether they
are intended or not. This is the first rule. There
is no doubt regarding management’s responsi-
bility for the social impacts of its organization.”

UPS is heeding that rule when it makes the
effort to translate all its package-truck miles
(something it was already measuring) into data
about emissions of CO2 and NO2—and then
shifts more package volume onto rail routes to
lessen that impact. Nike heeds the rule when it
compels all its suppliers to adhere to a code of
conduct forbidding the kinds of child labor prac-
tices that human rights watchdogs discovered in
the late 1990s. In both cases, the impacts are ob-
vious if not easy ones to mitigate. Sometimes,
though, the opportunities are not so clear to the
world or the company. Coca-Cola, when it ex-
amined its carbon footprint, discovered that the
most greenhouse-ghastly aspect of its business
was its installed base of more than 9 million
coolers and vending machines. The company is
in the process of changing over to units that are
more fuel-efficient. Along the same lines,

Nestlé’s VP of innovation, Helmut Traitler, says
his company is working to develop ice cream
products that needn’t be frozen until they reach
the grocer.

Carpet manufacturer Interface may be the
company that has taken Drucker’s “first rule”
most to heart. Its goal, as evangelized by long-
time leader Ray Anderson, is to achieve zero
impact on the environment (in a notoriously
chemical-spewing business) and in fact to be-
come a closed-loop, negative impact business
by 2020.

Taking action. A company usually knows it
is contributing to negative externalities, and
the world knows it, but the contribution is not
direct or precisely measurable. Coca-Cola, for
example, might know exactly how much water
its production process consumes but might
not know how much that level of consump-
tion destabilizes global water supplies. In such
cases, the wrong thing to do would be to deny
the seriousness of the problem or one’s role in
it. If the world perceives, however vaguely,
that you are part of the problem, and you have
organizational competence that can be ap-
plied to a remediation effort, you will only
gain by being seen as part of the solution.

A fine example is Wal-Mart’s green construc-
tion efforts in China. As it expanded into that
market, the retailer wanted to uphold the
same environment-friendly building standards
it had established elsewhere but was thwarted
by local contractors’ lack of skills and knowl-
edge. The easy response would have been to
say, “Oh well—we tried.” Wal-Mart opted for
the much harder response, taking upon itself
the task of training those local contractors to
do the job. Meanwhile, it took a similar level of
action with its private-label jewelry line by
adding a country-of-origin stamp to assure cus-
tomers that the precious metals were sourced
responsibly. No one could reasonably say that
Wal-Mart itself is the direct cause of social ills
associated with gold and silver mining in many
parts of the world. It does not need to take
ownership of those externalities. Yet by taking
action, it can refuse to be complicit.

Sometimes, taking action is a step toward
taking ownership. In the 1990s, John Brown of
British Petroleum actively campaigned for
more government regulation of emissions in
his industry. Brown knew BP was part of a soci-
etal problem, but he also knew that no com-
pany could survive a unilateral principled

Time to Take Ownership?

In November 2009, more than 2,000
villagers in Mehdiganj, India, staged
a march to demand the closure of a
Coca-Cola bottling plant there. At issue:
whether the company had overextracted
groundwater even as a serious drought
threatened the region. This wasn’t the
first such complaint: According to India’s
Central Groundwater Board, groundwa-
ter levels in Kala Dera, the site of another
Coca-Cola bottling plant, had plummeted
an unprecedented 19 feet from 2007 to
2008.

It’s a perfect example of scale, sensors,
and sensibilities combining to make an
issue of an externality. The company is
taking action on various fronts around
the globe as it internalizes the issue, re-
searching threats to fresh water supplies
and how to counteract them. The ques-
tion is: Is taking action enough, or is it
time for Coca-Cola to take ownership of
its impact? To the company’s credit, it’s
not burying its head in that dry sand.
This is the right debate for its executives
to be having, and they’re having it.

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stand. It would be just short of martyrdom to
undertake a drastic reduction of emissions
when competitors were not putting the same
burden on themselves. Brown also thought BP
was agile enough to be very competitive in a
changed game.

Taking action, however, need not imply any
future ownership of a problem. When microfi-
nance pioneer and Nobel laureate Muham-
mad Yunus challenged Adidas with the ques-
tion “why shouldn’t all the world’s children
have shoes they can afford?” the company de-
cided to act, not because it was to blame but
because it had special competence to engineer
a “one euro shoe.”

Taking interest. For impacts that are far too
remote to assign accountability, but where it is
possible to see a connection to a company’s ac-
tivities, it makes sense to contribute to amelio-
ration efforts. This is not admitting any culpa-
bility; it is demonstrating a special concern for
troubles that are closer to home, so to speak.

Often a company’s activities in this ring ap-
pear indistinguishable from philanthropy, in
that they support other organizations with spe-
cific competence to address the chosen issue. Yet
they are imbued with relevance. When, for ex-
ample, we spoke with Chris West, who directs
Royal Dutch Shell’s global philanthropic efforts
through the Shell Foundation, he explained that
the organization steers its contributions into
areas associated with cleaner and more efficient
energy consumption. “We deliberately took as a
starting point the fact that we would focus only

on issues aligned to the business footprint of our
parent,” he said. “So, for us, that means tackling
energy poverty issues and energy environment
issues.” It partners with a nonprofit organization
called Envirofit, for example, to help create an
affordable and cleaner-burning alternative to
the cookstoves used extensively in poorer re-
gions of the world. Applied in such directions,
Shell’s resources and brand resonate for addi-
tional benefit.

And what becomes of philanthropic oppor-
tunities that fall outside this framework? AIDS,
for example, is a terrible disease but cannot be
said to be an impact of a particular corporate
activity. Yet many companies have made ame-
liorating its effects in Africa a philanthropic
priority. Some observers salute the Project Red
campaign as evidence of growing corporate so-
cial responsibility. Others might say, “You’re
naive—it’s just cause branding.” Our position is
that there’s nothing wrong with good market-
ing, especially when it serves society. But we
wouldn’t classify these as acts of responsibility,
because none of the computer makers, jeans
fashioners, or skateboard makers supporting
Project Red is responsible for AIDS in Africa.
Outside the third ring, profitable companies
can afford to be generous—and should be—
but however laudable their philanthropy, we
doubt it buys them any “offsets” for the nega-
tive externalities they fail to address.

We’re in This Together

As organizations become more oriented to-

The Beauty of Market Solutions

When your neighbor plants a beautiful lawn
that you see from your window, you’re the
beneficiary of a positive externality; when he
mows that lawn while you’re trying to concen-
trate, you’re the victim of a negative one.

This duality scales up to larger cases. For ex-
ample, airlines lobbied recently to expand a
small airfield near both our houses in Massa-
chusetts: One of us joined HUSH, a group of
local residents who organized because they
feared the noise; the other rooted for the in-
crease in air service, because it meant easier
travel logistics. It’s a typical divide on a
NIMBY issue: You want the benefit, but I
won’t stand for the externalities, at least Not
In My Back Yard.

Fights like this become political when there
is no market in which these conflicting values
can be exchanged. An issue must be internal-
ized, however, if five questions about it can be
answered in the affirmative:

Can the cause be determined and
attributed?

Can those affected be identified?
Are affected parties unable to opt out of

the impact?
Can the impact be measured?
Can a price be put on it?
When the answer to all these questions is

“yes,” there’s often a straightforward solu-
tion: A payment can be negotiated, to be ex-
tracted either by a market mechanism or by a

civil action like a tax.
This is the idea behind the carbon tax. Most

emissions can be measured and traced, so the
challenge lies in assessing the incidence and
the cost of the impacts. Some are literally glo-
bal—if you believe there is a nonzero impact
on climate—and others are more local, like
smog in the San Gabriel valley. Setting a mar-
ket price for emitting a ton of carbon is one
way of ensuring corporate responsibility.
When a company pays the tax (or purchases a
license to emit or trades emissions credits in
an exchange), it internalizes the impact of its
activities.

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ward the gradual internalization of externali-
ties, we predict that an interesting shift will
occur. Reflect for a moment on the recent
emergence of “social enterprises,” a new class
of organization designed first and foremost to
produce social benefits. Unlike a charity, a so-
cial enterprise does not rely on donors; it aims
to turn a profit sufficient to sustain its ongoing
operations. For example, Grameenphone was
founded on Iqbal Quadir’s realization that
nothing could do more for economic develop-
ment in Bangladesh than a communications
network. This motivation spawned the largest
mobile phone company in the country, earn-
ing returns for all its investors.

Now consider that if a traditional business,
founded on the pursuit of profit, takes on
greater responsibility for externalities, it be-
comes quite a near neighbor to a social enter-
prise, founded for social benefit but taking on
the challenge of being commercially viable.
The bright line that has traditionally been
drawn between for-profit and charitable orga-
nizations starts to blur.

One implication is that over time, a common
performance yardstick visible to all sectors—

consumers, business managers, philanthropists,
regulators, citizens—will begin to take hold. And
as it does, many kinds of benefit-engineering
(analogous to financial engineering) will
emerge: Today you can offset the carbon foot-
print of your flight; tomorrow Brazilian villages
will package their carbon fixation for sale to
emitters, and who knows what the carbon de-
fault swap of the future will be? It will remain
the job of government to set the standards for
measurement and ensure that they are properly
carried out and made public. The markets, once
in possession of full information, should be able
to do the rest.

This is the thought we will leave you with:
As the boundaries between businesses and the
nonprofit sector erode, adversarial relation-
ships will become cooperative. A consensus
will emerge that we are all responsible for our
world and must work together to make it bet-
ter—and we’ll all wonder how we could ever
have thought otherwise.

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