The Senior Management of Northern Rock - Essay Example

?Ethics and CSR Question Can high salaries be justified for the senior management of Northern Rock? Should senior management pay be regulated? Answer Northern Rock Bank was the first British bank that faced crisis in the last 150 years during 2008 financial crisis. The two major reasons of the bank run was the huge amount of lending to the borrowers that the bank made without considering mortgage against the loan. During the phase of 1990-2006, the property market was blooming as a result the lenders took the risk of taking loan and thus the multiple debt issue became a serious problem for the individuals who are not able to pay back the loan they took in time. They even lost their property due to different issues but had to stick to the loan they had taken. The situation was even more hardened by the irregular effects of taxations and benefits which favoured lower income group. The rise of income at that time was very slow as a result the individuals tried to take loan beyond their capability of repayment (Knight, 2011). Though the bank was facing financial crisis the business executives of the bank were given huge salaries. The fees to the investment bankers, law firms and the public relation agencies in the final year of Northern Rock’s existence amounted to ? 127.7 million in April, 2008. This issue led the management to arrange things out. The senior management pay was not justified since the bank ran into the crisis and was not able to pay the customers of the bank their savings amount. The senior management should have regulated the pay keeping in mind the crisis the customers are facing. The components of an executive pay consists of the following: the basic fixed salary, annual bonus, stock option and the long term incentive plan (Goodman, 2013). The basic fixed salary is based on the benchmarked salary of the peers of the same industry. Annual bonuses are based on the accounting measure of the performance such as EPS or the Return on Equity. Stock options give the executives the authority to buy the shares of the firm at a particular price which is specified for a pre-specified period. The long term incentive plan is based on the cumulative performance of the firm’s rolling average of the last three to five years (Sin, 2001). All the components of pay of the executives are not justifiable in case of Northern Rock Bank since the bank was not performing up to the mark. The bank ran into crisis and did not have the money to pay the savers but the executives were paid huge amount even when they performed poorly. Due to the huge salary of the executives, workers were facing suspension and the jobs were outsourced from overseas (Reenen, 2012). In spite of facing crisis, the bank did not cut down their expenses. The executive pays were shielded from the down-sided risk by the management. When the price on the stock option was lowered the executive’s stock plans were altered, reissued or cancelled so that they do not face tremendous loss, but the bank did not inform the customers about the loss and thus did injustice to them (Koslowski, 2011). The regulation of the executive pay was seriously needed at that time to deal with the adverse situation. It should have being strong enough so as to make the situation justifiable for the customers of the bank. Pay and bonuses should have been regulated with the major part paid up in shares and which are locked up for several years and are subject to regain (Culpepper, 2012). According to the new rules it is necessary to provide the remuneration report. This is divided into two parts: a forward looking policy report, which included the exit payment and an implementation report over the last financial years. The shareholders have the right to know the rules and regulations of the companies and even have the right of voting. The shareholders should have been informed about the above. The reforms should have bought a great positive change in the system and should have saved the bank from facing the crisis. The forward looking policy should have included the key elements of pay and the information supporting the achievement of the company’s strategy (Government of UK, 2013). It also should have included the details of the remuneration provisions contained in service contracts. The implementation report consists of the actual payments made to the senior management as a “single total figure” of the remuneration for each executive (Tynan, 2013). Remuneration statement related to votes should have also been implemented by the management of the bank. The necessary vote on pay policy would have been held once a year unless the management chooses to leave the policy for remuneration unchanged. The bank should have also reported the details of whether they were able to meet the performance process and an evaluation between bank’s performances and the executives’ pay. The shareholders should also have an annual advisory vote on declaration to approve the implementation report (Rachaels, 1986). The surprising fact is that the pay of the executives is decided based on the performance of the organisation. When their performance is not up to the mark and the organisation is facing tremendous loss, then high salary is not at all justifiable. But in the case of Northern Rock Bank the executives were highly paid even when the bank faced the financial crisis. The salary should have been regulated at that time but the regulation was actually made at the later days when the bank was nationalised (Cristina, 2008). Thus it can be concluded that high salaries were not justifiable to the executives of the bank at the time of crisis and thus a reform was needed so as to safeguard the assets of the customers. The bank authority should not only think about their benefit they should also see to the fact that the customers should not be deprived of their rights. Question 2 Do you agree with the view of Milton Friedman that shareholders are the most important stakeholders? Answer Shareholders are the person or company or any institution who own at least one share in a company. They can also be referred to as stockholders. They are the owners of the company. They do get the profit if the company makes profit and if the company faces loss they are bound to face loss. The stakeholders are the persons who take interest in a company or enterprise. They are the employees, suppliers, investors and the customers. Shareholders are stakeholders in an organization but stakeholders are not always shareholders because stakeholders may not buy shares they can only be interested in the performance of the organization. Milton Friedman’s Stockholder Theory argues that a business’s sole social responsibility is its stockholders and their aim is to maximize profit for them without using immoral means. The resources that are available in the organization are to be utilised to its fullest so as to earn profit. Stockholders are the people who have straight away invested in the company and thus have the chance to lose if the company faces a loss (Friedman, 1962). It can be said that stockholder theory is the most excellent ethical process to business as it does not need leaders to reflect fair decisions or to think about customers. A company manufacturing and selling unsafe product will make loss and thus stockholders will be affected. Friedman elaborates two key points in light of the theory. First being that there is no morality in business which does not contain controversy and the mangers are not that ethically bound that they will be making ethical decisions. The second point says that by maximising oneself for a longer period will bring a good result (Smith, 2003). The Stakeholder Theory proposed by R. Edward Freeman concentrates on the fact that the leaders who desire to maximise the organisations capabilities will capture stakeholder interest in account. The stakeholder theory may assist managers for analysing how the company fits into the large external environment in which they are operating in. It also analyses the benchmarked operational procedures influence the stakeholders within the company (stockholders, employees, etc) and outside the company (financers, customers etc). The theory suggests that a business manager is ethically bounded to use the resources so that they can serve all the stakeholders who are involved with the business including the community, employees and the shareholders (Ronnegard, 2011). The manager should undertake responsible actions in the long run that will benefit the firm. The investment should have a direct business purpose and expects to generate sufficient benefits for the future for its shareholders. In comparison with Friedman’s Stockholder Theory, if a company manager concentrates only on how to maximise stockholder wealth then stakeholders can easily be ignored. It can be concluded that concentrating only on the stockholders theory will be risky. Thus Friedman’s view, “shareholders are the most important stakeholders” do not hold good. Friedman’s concepts lie on the fact that the responsibilities of management are generally understood as a declaration in support of income affectation to corporate “social responsibility.” According to the theory, among the various factors connected with a business, the shareholders have unmatched advantage over the corporations. The core of Friedman’s argument rests on private property and the complete control of that property that is bestowed by the virtue of its private ownership. It is their privilege to run the firm themselves or to hire someone else a professional manager. The problems with the Stockholder Theory are the following: The theory assumes that all the forces of competition are satisfactorily dynamic but in practical they are not that. The reason behind is the existence of central regulations. The Central regulations are very important to act in a fair manner. The regulations generated by the government direct the individual and the market towards an ethical world of business. The explanation of the theory is not consistent with the law as it does not support stockholder’s right (Younkins, 1997). When costs are not paid then the maximisation of profit becomes insufficient. The examples of such can be pollutants, inadequately educated labour force etc. The theory results in discrepancy by triggering mangers to behave unethically to maximise profit. When the only goal of a manager is to achieve profit, he/ she can take unfair means to achieve it, which is not ethical for a business and it can affect the working condition of the organisation. It will tremendously affect the stockholders by bringing loss to them and even the stakeholders are affected like the employees of the organisation (Hawke, 2011). Another problem with the Stockholder theory is the allocation of income that results from the uncontrolled profit maximisation which becomes unequal. Maximization of profit is publicly incompetent when the buyer has knowledge inferior to sellers. The buyers can get cheated in that case. The traditional Stockholder theory states that not only the stockholders satisfaction should be taken care off but stakeholder’s satisfaction should also be taken into account (Pfarar, 2012). It is important for an organisation to concentrate on the environment around it by releasing clean stacks of smoke and by cautiously examining the wastes that are dumped in the water bodies. These can be carried out by purely following laws that are customized by the government (Mariane, 2012). The organisation should also take care of the community in which they are planning new establishment because if they help their neighbours they will gain the support of the community, which they require if they are opposed by the opponents at times. The Stockholders Theory does not explain the social responsibility towards the employees who are the important part of the organisation. Organisations that promote better working environment become a great organisation for the employees. If the organisation takes care of the employee’s need and satisfaction the employees will respect the organisation’s decision and they will take interest in the working of the organisation and the organisation will be successful in meeting their goals. Question 3. Use any moral theories to critically evaluate the actions of the senior management at Northern Rock. Answer: Northern Rock Bank faced a serious financial crisis during the 2008 which led to the nationalisation of the bank. The bank has recently been owned and operated by Virgin Money. The Northern Rock brand was phased out in 2012 and was replaced by Virgin. The situation was so critical that the savers queued outside the bank to take out their money so that they do not lose any interest on their invested amount. Northern Rock’s rapid growth was fuelled by aggressive lending to borrowers. Its administrators at the Financial Services Authority were diverted and philosophically opposed to question its business plan and risk models. Newcastle-based bank exploited the safety rules of the bank and was left with very little equity to absorb the unexpected losses. Though the bank was facing the crisis the business executives were given huge salaries. This issue led the management to arrange things out. The fees to the investment bankers, law firms and the public relation agencies in the final year of Northern Rock’s existence amounted to ? 127.7 million in April, 2008. The situation basically arouse due to the huge loan that the borrower took from the bank without keeping asset or property as mortgage. The other issues were the : inflation rising to 28% , the Gross Domestic Product (GDP) decreased by 3%, the government lending shortage reached to 10% and the government had to go to International Monetary Fund(IMF ) for seeking help by taking loan to deal with the crisis that leaped up. Though the bank could not have any control on the first three issues but they could have thought twice before going to IMF for seeking help. The difficulties in the bank took place because of the American subprime market. The failure was also due to the regulation problem of the bank which could not regulate the salaries of the executives but they took a wrong step of making the customers suffer. The ethical theories which can be linked with case are deontology and utilitarianism. Deontology is one of the normative theories regarding which choices are required morally and forbidden. Deontology elaborates the areas of moral theories that direct and charge our choices of what a person must to do in disparity to that. It leads and assesses the person that how they should be (DeGeorge, 2011). It judges the morality of the person by evaluating the nature of action and the determination of the agents rather than the goals achieved. The reason for the shift from the action to duties is that in spite of one’s best effort one cannot predict and control his/her future. A person is blamed or admired for his/her action within his/her control and that involves the willingness to his work because of his/her achievement. The right of an individual is acknowledged and it is unavoidable. There are two problems with deontology. They are: Actions becomes either right or wrong and these lines are often drawn wrongly. Another problem being the moral dilemma created when duties conflict and there is no possible solution for rectifying them. Linking the case of Northern Rock bank and the theory it can be said that the moral values of the executives were not right unto the fact that they are not charged with good choices of morality. Though the bank was facing crisis the executives had the moral to take high pay and the management did not take care of the issues. High salaries cannot be justified to the executives since the bank is facing crisis. The management should have worked upon the changing situation positively so that both the savers and the management are satisfied with the situations. Instead the bank lost confidence on their repayment policies and the situation was such that they locked the doors and prevented the savers to come in the bank. They even freeze the hard earning savers accounts so that they cannot withdraw money. In case of Northern Rock Bank, the savers were the sufferers as they were cheated by the bank when they were not given their money back which was their rights. The bank failed to provide the privileges that they promised the savers. The bank faced this collapse mainly because of the huge loan that they have given to their customers who have not paid them regularly and even they gave loan to those customers who were not able to keep any asset as mortgage. The main sufferers were the depositors of money who expected to get good return from their savings. Utilitarianism theory is another normative theory which describes that the right course of action gives the maximum utility. It defines that the course of action justified should maximise happiness and reduce pain. The moral value of any action is justified by its outcome though there were debates about the fact that how much thoughtfulness should be provided to an actual consequence. These consequences are either foreseen or intended. It can be characterized as the reductive process which holds the moral ethics of the firm. It can be compared with deontological ethics, which does not regard the result of an act as determinant of the moral value. The main purpose of the theory is to focus on the acts and habits leading to pleasure and happiness. It has been regarded as the natural principles of a democratic system functioning from simple mainstream without harming the individual rights. In the case of Northern Rock bank the situation was such that the management of the bank did not take the right course of action to satisfy the customers and thus the situation went on worsening till the bank was nationalised. The customers not only suffered from the situation made by the bank but also gave up the hope of receiving their invested and saved amount. The right course of action should have made the situation better but they acted in such a way that they went against the moral of ethics that are followed by organisations (Cavalieri, 2001). Question 4 Might Northern Rock affect public views on corporate social responsibility and business ethics? Answer Corporate Social Responsibility (CSR) is understood as the process by which a firm integrate economic, social and environmental concerns in to their values, decision making, culture and strategies and thereby setting up better exercises within the firms and improve society. The concept CSR has made many companies confident to implement ways to take the entire stakeholder’s interest in to account during the execution process of the organization. CSR activities help the organization to engage new employees and retain them for further contribution to the organization. An organization when performing at its best attracts people who will get engaged in the organization as an employee. Through CSR activities the mass comes to know about the organisation and its operation as a result they get interested in the organisation and desire to join it. If the organisation effects negatively to the society, the public oppose to it and as a result the organization faces huge difficulty in normal day to day business. This can be well described by the Northern Rock bank situation. The wrong operational strategies of the bank affected the society to such an extent that the bank surrendered to the situation and stopped interaction with the people of the society who happened to be the customers of the bank. As CSR movement went strong, many companies gave emphasis on improving social and economic performances. Some companies argued on the belief that it can give profitable result by decreasing the risk of harmful publicity and shareholders activism. Many companies even made ethical cases for CSR saying that organisations do have some honest values towards the people and the environment which succeed the single chase for profit. Ethics and CSR are the term which are frequently used interchangeable in an organisation. Ethics deals with the norms and values of the organisation and judge what is right and what is wrong for the organisation whereas CSR is about expressing those values by applying different programmes and policies (Crowther, 2004). A company is responsible for the society it is working in and has some duties towards it which encourage them to expand their wings in different communities. Thus the universal amalgamation of the system of the company and public establishment aggravates the state of incompetence and liquidation and many types of imbalances that emerge in every operating unit. The people working in the company should have strong interest in the company and have the core responsibility of handling work with seriousness and thus they discover a new bond of belongingness with the company (Simpson and Taylor, 2013). In the case of Northern Rock Bank it can be said that both CSR activities and the business ethics were absent. That is the reason why there was such a big crisis which added flame to the public view. The public is very much aware of the CSR activities undertaken by the organisations and business ethics they follow so the leaders of the organisation cannot avoid these two things on a whole. The news of crisis did not remain hidden from circulating in the public and the customers of the bank did what was needed to save their money. The ethical theory which defines justice deals with the moral choices that measures the privileges of the people and makes solution to the damage that are done to them. Justice was not made to the customers of the bank in this case. No solution was provided to them when their money got stuck in the bank. CSR activities were developed by many companies to create values that are pooled by the business and the common people that cannot be applied arbitrarily. But these are applied to a number of issues that the business has to make positive contribution in and obtain competitive advantage. Competitive advantage can only be gained if the company gives positive contribution to the society or else they will face disturbances in their day to day work. The organisations take strategies to create new ways of improving their CSR activities and take measures that will eradicate social problems. The companies who undertake the CSR activities take interest of getting better opportunity from the society to make their manufacturing unit and thus they ensure a smooth operation from the business (Schwartz, 2011). In 2007 when the bank faced with crisis the financial situation of the society was not also stable that is also one of the reasons which infuriated the customers for demanding their savings from the bank. The uneven effects of the tax benefit were good for the lower income group which discriminated the class and thus there was an uprising too for that. The problem of house price rising made the situation worse and the people at that had to take loan and at that time large mortgages were not available. When the customers of the bank and even the common people are facing this kind of problems the bank did not take any initiative to comfort them and give them the right decision. The bank did not find it important to take up any activity to help the people to get lands at cheaper price and ensure them that they are with them. The bank surrendered to the situation instead of staying by the side of their customers and also the people of the society (Ronald, 2003). When the bank failed to correct their situation on 17th February 2008, the UK treasury announced the nationalisation of the bank which made many reforms to the bank and relieved the customers. The bank was nationalised with few guidelines. Government became the sole shareholder of the bank through UK Financial Investments Limited. The customer’s investment was fully protected by the government through the Financial Services Authority. Government appointed arbitration panel who decided upon the fair price of the shares that are offered to the shareholders. A significant number of employees lost their jobs because of the downsizing regulation (Parliamentary Business, 2009). Reference List Blumberg, J., 2001. The ethics of corporate social responsibility. [online] Available at: [Accessed 2 July 2013]. Cavalieri, E., 2001. Ethics and corporate social responsibility. [online] Available at: [Accessed 2 July 2013]. Cristina, M., 2008. Northern Rock: the crisis of a UK mortgage lender. [online] Available at: [Accessed 2 July 2013]. Crowther, D., 2004. Perspectives on corporate social responsibility. England: Ashgate Publishing Company. Culpepper, P., 2012. The politics of Executive Pay in UK and US. [online] Available at: [Accessed 2 July 2013]. DeGeorge, R., 2011. Business ethics. New Delhi: Dorling Kindersley Pvt. Ltd. Friedman, M., 1962. Capitalism and freedom. Chicago: The University of Chicago Press. Goodman, T., 2013. Proposed Reforms to UK executives. [online] Available at: [Accessed 2 July 2013]. Government of UK, 2013. Director’s Remuneration Reforms. [online] Available at: [Accessed 2 July 2013]. Hawke, P., 2011. Stakeholder’s Theory Vs Stockholder’s Theory. [online] Available at: [Accessed 2 July 2013]. Knight, A., 2011. UK is ahead of the curve on banking reform. [online] Available at: [Accessed 2 July 2013]. Koslowski, P., 2011. The ethics of banking: Conclusion from the financial crisis. London: Springer Dordrecht Hiedelberg. Mariane, J., 2012. Business ethics case studies and selected readings. USA: South Western Cengage Learning. Parliamentary Business, 2009. Corporate Governance. [online] Available at: [Accessed 2 July 2013]. Pfarar, M., 2012. Shareholders Vs Stakeholders Theory. [online] Available at: [Accessed 2 July 2013]. Rachaels, J., 1986. Kantian Theory: The Idea of Human Dignity. [online] Available at: [Accessed 2 July 2013]. Reenen, J., 2012. UK chief executives paid for performances. [online] Available at:< http://cep.lse.ac.uk/pubs/download/cp373.pdf >[Accessed 2 July 2013]. Ronald, R., 2003. Ethics and Corporate Social Responsibility : Why giants fall. United States: Praeger Publishers. Ronnegard, D., 2011. Shareholders Vs Stakeholders. [online] Available at: [Accessed 2 July 2013]. Schwartz, M., 2011. Corporate social responsibility: An ethical approach. Moorebank: NewSouth Books. Simpson, J. and Taylor, J., 2013. Corporate governance, ethics and CSR. London: Kogan Page Limited. Sin, J., 2001. Executive Pay reform. [online] Available at: [Accessed 2 July 2013]. Smith, H., 2003. Shareholder Vs Stakeholders. [online] Available at: [Accessed 2 July 2013]. Tynan, R., 2013. Executive pay Reform. [online] Available at: [Accessed 2 July 2013]. Younkins, E., 1997. Stockholders Vs Stakeholders. [online] Available at: [Accessed 2 July 2013]. Read More