Ethical Leadership in Tesco Plc - Term Paper Example

A critical evaluation of governance arrangements and evidence of ethical leadership in Tesco Plc Executive Summary The purpose of corporate governance is to facilitate effective management for the long-term success of the company. The Code guides the organization based on the underlying principles of good governance. At Tesco the single focus is to maximize shareholder value. Corporate Governance is weak at Tesco as they have been violating certain governance codes. The Board is effective and experienced with international exposure. However, accountability and transparency is lacking at Tesco. The company has failed to get shareholder support because of the excessive pay granted to the executive directors. No form of effective leadership has been evident in the case of Tesco. Their CSR activities are also meant to appease the shareholders and to comply with regulations. They have been accused of unethical trading and of exploiting the farmers. Stronger corporate accountability legislation could ensure that retailers such as Tesco deliver right reporting on their CSR activities. Building social capital could help the company legitimize its position in the society. Table of Contents 1.0 Introduction 1 2.0 The theoretical landscape of governance and leadership 2.1 Theories of Corporate Governance 1 2.1.1 The economic theory 2 2.1.2 The agency theory 2 2.1.3 The resource dependence theory 2 2.1.4 The social-institutional theory 3 2.1.5 Summary of theories 3 2.2 Leadership theories 4 2.2.1 Transformational leadership 4 2.2.2 Servant leadership 4 2.2.3 Summary of the theories 5 2.3 Tesco’s governance roots 5 3.0 Conformance Vs Performance led governance 5 3.1 Conformance dimension 6 3.2 Performance dimension 6 3.3 Tesco’s position 6 4.0 CSR frameworks and Tesco’s CSR position 750 7 4.1 Carroll’s Pyramid of CSR 7 4.2 Seven position CSR 8 4.3 Tesco’s CSR 9 5.0 Governance arrangements and unethical leadership in Tesco 5.1 Leadership 10 5.2 Effectiveness 10 5.3 Accountability 11 5.4 Remuneration 11 5.5 Shareholder Relationships 11 6.0 Conclusion 12 7.0 Recommendations 12 References 14 Appendices 17 1.0 Introduction Tesco, one of the world’s largest retailers, operates in 14 countries and employs over 492,000 people (Tesco Plc, 2012). The group has expanded into different markets with different formats and with different products. No one tries harder for customers and treat people how we like to be treated are their core values. The Board at Tesco comprises six Executive Directors and eight independent non-executive directors. The group controls more than 27% of the UK grocery market but Competition Commission and Office of Fair Trading indicate there are allegations against the company for abusing its power (Friends Of the Earth, 2004). Tesco’s success is coming at a high price for the local communities. Farmers too are losing out as Tesco profits. In addition, Tesco came under scrutiny as excessive annual bonus and long-term incentives have been paid to the full time directors. They have been warned by America’s CtW Investment Group in addition to two other advisory groups - RiskMetrics and Manifest (Finch, 2010). Two of the incentive schemes share a single target, which is against the norms stipulated by UK Governance Corporate Code. Tesco has chosen to report against the new UK Governance Corporate Code before it applies on them fully (Friends Of the Earth, 2004). This contradicts their claim to be committed to the highest standards of corporate governance. The agency theory and the social-institutional theory of corporate governance would be applied to evaluate the governance arrangements and the leadership at Tesco. 2.0 The theoretical landscape of governance and leadership 2.1 Theories of Corporate Governance Corporate governance (CG) pertains to the exercise of power in corporate entities. This became essential as people began to organize themselves for a common purpose. Governance thus ensures that the power in the organization is harnessed for the agreed purpose. Corporate Governance has been defined as the system by which business corporations are directed and controlled. The system so developed specifies the rights and responsibilities of the different participants in the corporation while the rules and regulations are spelt out. CG contributes towards the economic and social wellbeing of an organization as it provides incentives and performance measures to achieve business success (Clarke 2004, p. 2). It also helps in providing the accountability and transparency to ensure equitable distribution of wealth. However, an organization faces dilemmas and challenges in aligning the diverse interests into forms of productive collaboration. These are extensively elaborated in the different theories of governance. 2.1.1 The economic theory The economic theory has its basis in the economic development of industrial capitalism. This theory is powerful under stable economic conditions and businesses focus on generating wealth for the stakeholders. However, it cannot be expected that the directors of a firm would ensure same standards of wealth management as their own company. Vested interests of the controlling group are likely. 2.1.2 The agency theory The agency theory highlights the board as a monitor of management activities to minimize agency costs, with the interest of the shareholders in focus. It considers the relationship between the non-managing owners and the non-owing managers. This theory rests upon the contractual view of the firm (Clarke 2004, p. 4). This is based on a contract between the financiers and the managers. Managers raise funds from the financier and put them to effective use while the financiers need specialized human capital to generate returns on investment. However, keeping the interests of the shareholders in mind, the managers work under constraints to reduce misallocation of funds. The agency theory is based on the self-interested utility maximizing motivation of individualized actors and hence the relationship between the shareholders and the management could be strained. Contracts tend to be incomplete and are subject to hazards because of the nature of people which include self-interest, bounded rationality, risk aversion (Lubatkin, Lane, Collin & Very, 2005). Information is distributed asymmetrically in an organization and agency problems can also occur as agents take actions that favor their interests. 2.1.3 The resource dependence theory The resource dependence theory focuses on the fact that even efficient companies can fail if they are unable to gain access to the scarce resources that may be critical to their survival. This theory is based on the assumption that successful organizations posses internal structures that match environmental demands. Coping effectively with uncertainty is essential and the directors serve to link the organization with the external environment aimed at reducing uncertainty. This link is essential as firms need to maintain good relationship with external stakeholders and even non-contractual stakeholders are linked to the firm. However the benefit to the firm is dependent on the extent to which the directors are able to provide access to resources and information (Clarke 2004, p. 9). 2.1.4 The social-institutional theory The social-institutional theory implies a deeper integration of business with the society. There is a great emphasis on the way in which the companies and their leaders create market realities based on their own intentions. Companies are embedded into their social system and they impact upon and are affected by a cross-section of shareholders much more than those that are contractually linked to the firm. Social enterprises seek legitimacy both internally and externally. The local needs of primary stakeholders are matched with the governance process while managers remain transparent and accountable (Mason, Kirkbride & Bryde, 2007). However, asymmetric information can hinder the achievement of the goals. Regular interaction between different levels of staff is unlikely. 2.1.5 Summary of theories All the four theories discussed above have both advantages and disadvantages. The economic theory is powerful under stable conditions but vested interests of the controlling group are likely. While the agency theory aims to minimize the agency costs it is based on the self-interest of the individualized actors. The resource dependence theory help cope effectively with uncertainty but its benefit can be derived only if the directors are able to provide access to resources and information. The social-institutional theory focuses on the needs of the primary stakeholders whose needs are matched with the governance process but asymmetric information can hinder the achievement of goals. 2.2 Leadership theories Governance can be effective only when the right leadership steers the organization towards achieving the corporate goals. Trust is an important factor which affects the quality of corporate governance. Poor leaders can create a culture of self-delusion. Poor leaders face dilemmas because there is no satisfactory choice that suggests itself on the evidence available (Rickards & Clark 2006, p. 18). Leadership decisions are most often taken under conditions of uncertainty. This is because of incomplete information on the consequences of the decisions. Ethics is now seen as an important component of leadership. Ethical conduct of good leaders is essential and good leadership is not just about achieving economic goals of the company. Good leadership pertains to treating people according to the norms of morally acceptable behaviour. Effective results can be achieved if priority is not placed on treating people well. 2.2.1 Transformational leadership The leaders should be able to lead the followers to higher levels of ethical development (Rickards & Clark 2006, p. 201). The dilemma that the leaders confront is between beliefs about morality (conduct) and beliefs about achievement (effectiveness or performance). MacGregor Burns developed the leadership model based on Maslow’s Hierarchy of Needs which emphasizes that transformation and moral development of followers can be achieved. Commitment to broader ethical considerations is given priority over survival of the self. The transformational leader must be willing to engage with the different values and derive benefit from the constructive conflict between them. The true transformational leader increases awareness of the right, the good and the moral and elevates the followers’ need for achievement and self-actualization (Catherine, 2008). The focus of the transformational leader is on the commitment to the organization and its objectives. 2.2.2 Servant leadership Robert Greenleaf’s servant leadership is about attending to the moral needs of the followers (Rickards & Clark 2006, p. 202).The followers take on the ethical values of the servant leader, as per this model. The followers develop into morally responsible and autonomous leaders. There is freedom and willingness to undertake the duties of servant leadership (Catherine, 2008). The servant leader focuses on the followers while the organizational objectives are secondary. 2.2.3 Summary of the theories Transformational leadership will create an enthusiastic work atmosphere and ethical considerations are given importance. However, the success of this form of leadership is based on the ability and the willingness of the leader to motivate the workforce. In the servant leadership the focus on the leader is on the followers and in the process the leader might tend to overlook or neglect the organizational objectives. 2.3 Tesco’s governance roots The governance at Tesco is weak as they violate their own codes of conduct, apart from violating the UK Corporate Governance Code. In its Corporate Governance literature Tesco states that employees have the right to freedom of association but they have been accused of opposing unions in the US (Whiteaker, 2010). They demonstrate lack of business integration with the society, which forms the basis of the social-institutional theory. Tesco has been trying to extend the share option scheme to three years against the norm of one year in which the leaving or retiring executives can exercise their options (Felstead & Burgess, 2009). This demonstrates the motivation to maximize the self-interest of the individualized actors. While corporate governance is supposed to provide equitable distribution of wealth, the governance at Tesco is weak as no attempts to minimize the agency cost in the interests of the shareholders is apparent. Neither transformational leadership nor servant leadership is evident at Tesco and signs of unethical leadership can be perceived. Trust is a vital component of governance and absence of trust can be corrosive for the organization. 3.0 Conformance Vs Performance led governance Boards have to face the conflicting demands of conformance and performance aspects of running the business. Enterprise governance is a new framework that is being used as it attempts to bridge the gulf between corporate governance and business governance. The board and the executive members have the responsibilities of providing the strategic direction in alignment with the corporate objectives while ascertaining the appropriate management of risks and verifying that organizational resources are responsibly used (CIMA, 2004). 3.1 Conformance dimension Conformance dimension also known as corporate governance covers issues such as the roles and remuneration of the board of directors, of the non-executive directors, of the internal controls and risk management. Following the various corporate scandals focus is on the accountability of the professional accountants and effective control measures to be adopted by the audit committee. To ensure good corporate governance processes mainly independent and non-executive directors constitute the board, particularly the audit committee. 3.2 Performance dimension The focus in the performance dimension is on helping the board to make strategic decisions and understand the key drivers of performance. The focus is on strategy and value creation. It also aims to identify the critical points at which decisions need to be taken. A strategy committee is usually formed that reviews the strategy development and implementation process, challenges the information provided and assesses the key business drivers. Tools and techniques such as scorecards, continuous improvement, strategic enterprise systems, and invest committees help the board to focus on strategic direction. Case studies however reveal that these are not dealt coherently by the board. While conformance dimension focus on the accounting and audit aspects overseen by an independent committee, the performance dimension focuses on strategy and value creation. Both the dimensions use an independent committee for evaluation and implementation of the system. 3.3 Tesco’s position The Board at Tesco governs through a number of key committees – the Audit, Remunerations and the Nomination Committee. The Tesco Governance model is available in Appendix A. These committees are authorized to take decisions on behalf of the Board but within the parameters prescribed by the Board. The Board is informed of the work of these committees and any issues that require resolution are referred to the full board. These committees comprise of non-executive directors and these directors provide independent insight on governance matters. This indicates that they have been adhering to the guidelines provided by the Cadbury Report. The Nomination committee has been active in succession planning as they are engaged in finding a replacement for the CEO. The Remuneration committee is responsible for the remuneration of the executive directors and the senior management. The committee has been provided with sufficient resources to carry out its activities. The financial committed also deals with the control measures and financial statements. Despite these claims, as per their annual report, allegations of excessive pay to full-time directors have been made (Tesco AR 2011). The membership in the Corporate Responsibility Committee comprises of Executive Directors and senior managers. This does not include any independent directors. To measure performance Tesco uses a management tool called the Steering Wheel which has four quadrants and which in turn has several segments each with key performance indicators (KPIs). The targets are demanding but achievable and the senior management remuneration is shaped by the KPIs (Tesco Plc, 2004). Cause and effect in the Steering Wheel can be ascertained and the company is able to apply the performance-by-pay principle. This is applicable to the executive directors as well as the staff. 4.0 CSR frameworks and Tesco’s CSR position 750 Corporations and their role are challenged by social expectations as they perform their activities in different cultural settings (Sachs, Rühil & Mittnacht, 2005). The best known CSR framework is the Carroll’s framework which reflects on the economic paradigm as the basic layer of a pyramid. In all cultural settings economic responsibility is the prime concern. 4.1 Carroll’s Pyramid of CSR According to Friedman the only responsibility of businesses is to make profits. The first level of Carroll’s responsibility pyramid (Appendix B) is economic responsibility where individual interests are turned into common interests. The second level is characterized by legislation when a strong increase in the regulation of corporation activities can be observed. This is followed by the ethical responsibility as legislation reflects the norms founded in the society. Ethical responsibility includes even norms that are not legally founded but are still sanctioned by responsible societal groups. The philanthropic responsibility is the final level in the pyramid which includes corporate commitment and is based on voluntary behaviour of the firm. However, this pyramid appears to be an isolated domain and bears no reference to the different stakeholders that are critical for the survival and growth of the organization. 4.2 Seven position CSR Stakeholders in an organization can take diverse position on the issue of CSR ranging from purely economic to social agendas. The stakeholder/shareholder debate is central to the discussion as it separates people into political and ethical ‘camps’. The two extremes may represent the ‘pure’ versions of each argument but the ‘real life’ exists at a number of points along the continuum itself which makes the seven positions on social responsibility by Gray, Owens and Adams so useful. Pristine capitalists Shareholders wealth maximization is the prime concern as they have invested and hence they are the legal owners and they alone have the right to objectives and strategies of the business (Campbell, 2008). They view CSR as an impediment to business and they consider the social and environmental costs of doing business as the responsibility of the society, not of the organization (Will, 2011). Expedients They share the same values as the pristine capitalists but recognize that some expenditure on CSR may be necessary to position themselves in order to maximize profits. Accordingly they may engage in adopting the environmental policy or give small charities. Social contract position Businesses enjoy the license to operate as long as they abide by the ethical norms. If the organization is found to violate the norms, the license to operate can be withdrawn as in the case of Enron. Social ecologists They recognize that businesses have a social and environmental footprint and hence have the responsibility to minimize the footprints it creates. Socialists Socialists view the capitalistic system exploitive and unstable. They thus redress the imbalances in society and provide benefit to stakeholders other than the owners of the capital Radical feminists They argue that the society and businesses should be based on values such as connectedness, equality, dialogue, compassion, fairness and mercy. Deep ecologists This is the most extreme position of coherence in the continuum. They argue that just because humans are able to control social and environmental systems does not mean they should. If businesses focused on attending to every stakeholder’s interest, survival may be affected. The above two frameworks would be used to analyse Tesco position on CSR. 4.3 Tesco’s CSR Tesco demonstrates governance arrangements as it does have different committees with independent non-executive directors who meet at regular intervals and present their findings and appraisals to the board. However, merely having governance arrangements does not suffice. The committees have not been ethical in discharging their responsibilities. For instance, while they do have an independent Remuneration Committee which is supposed to be responsible for remuneration of the executive directors and senior management, the company has been accused of excessive pay to executive directors. This demonstrates unethical leadership in the organization. Other instances of unethical leadership include Tesco being ranked as one of the worst offenders on social and environmental issues and criticized for its CSR report being inadequately verified and incomplete (Friends Of the Earth, 2005). They claim to be committed to responsible sourcing (Tesco PLC 2012b) but they have been accused of crimes which include bullying farmers, crushing small traders and polluting the environment (The Independent, 2008). Its cost-cutting activities and aggressive tactics have been damaging its reputation. These suggest that shareholder maximization is the prime concern of the management as they consider CSR as impediment to business. However, they do recognize that some amount of expenditure on CSR and societal concerns would position them better and hence they engage in some CSR activities. They can hence be called expedients. The leaders at Tesco are unable to confront the moral or ethical dilemmas associated with leadership. As per Carroll’s framework, Tesco limits itself to the economic responsibility where individual interests are the prime concern. They violate legislation to suit their profitability and hence have not progressed as per Carroll’s CSR pyramid. 5.0 Governance arrangements and unethical leadership in Tesco 5.1 Leadership The company is effectively headed by a board as per their Annual Report (2011) and the board does provide entrepreneurial leadership of the company. Tesco has different committees as per the Corporate Code of UK comprising of non-executive directors who regularly meet and report their findings to the Board. However, they have not been adhering to the Governance Codes. As per the UK Corporate Governance Code at least half of the Board, excluding the Chairman, should comprise of non-executive directors, which has not been complied with at Tesco as they require independence (Tesco PLC, 2012a). As per the Code every three years there should be an externally led evaluation of the Board’s performance. At Tesco the last evaluation took place in 2007. There is neither any stakeholder engagement and nor are their dealings transparent. The Annual Report of Tesco only provides a list of achievements but does not state how it has deviated from the Code and the numerous fines and penalties that they have been subjected to. 5.2 Effectiveness The new Chairman has experience in banking roles in the private as well as the public sector. His appointment is mainly concerned with boosting the Tesco Bank. He chaired the remuneration committee at the Barclays and at Tesco he is the non-executive director (Kollewe, 2011). He comes with wide experience and Tesco is expected to benefit from his expertise. This appointment has been after a thorough process and endorsed by the entire board (Hall, 2011). In addition, Tesco takes in several internal candidates for the board. They have a strong and diverse team having functional capability and strong international experience (Creevy, 2011). 5.3 Accountability The board merely lists its achievements during the year in all of its annual reports. The company is aware that it has not complied with some of the codes of UK Corporate Governance. In fact it plans to report against the new UK Governance Corporate Code before it applies on them fully (Friends Of the Earth, 2004). Their systems are not transparent as they have been accused of maintaining double standards in their operations in UK and elsewhere (United Food and Commercial Workers International Union, 2008). The internal control systems too are weak as they demonstrate the difference between due diligence and compliance. Tesco was prosecuted when a discount sign was left on the display after the discounts were withdrawn and the counter staff refused to sell at discount (Key Media, 2012). While its due diligence was sound Tesco failed to secure compliance with the law, thereby demonstrating weak internal controls. 5.4 Remuneration The full time directors and executives are concerned with self interest as the company has been warned about mounting shareholder concern when almost one-third cast their vote against the remuneration report. Nearly half the shareholders fail to support the boardroom pay policy (Kollewe & Finch, 2010). This reflects investor outrage against the excessive pay awarded to Tim Mason, Tesco’s second highest paid executive, despite dismal performance. In addition, the outgoing CEO Sir Terry Leahy received about £10m in pay and cheap or free shares in 2010 while Mason got £7m. The remuneration committee of the company does not pay heed to the shareholder concerns. As far as the regular staff is concerned, Tesco does not provide a contract of agreement in the US and the pay in the US is much lower than that in the UK. The leave entitlement and the number of hours per week also differ across nations. 5.5 Shareholder Relationships Tesco claims to have a good dialogue with their shareholders through proactive meetings and presentations (Tesco AR 2011a). They seek shareholder views on a range of issues from strategy to corporate governance. They have been discussing issues such as performance and strategy as well as new developments. To appease the shareholders, Tesco has revamped its executive pay policy. However, this has primarily been done in order to avoid the shareholder revolt as in the previous year. After review and consultation with the shareholders, Tesco has decided to scrap the incentive scheme previously enjoyed by Tim Mason. This is an attempt to turn the shareholders’ attention away from the issue but Tim Mason is being compensated by way of bonus amounting to 80% of his salary as a reward for hitting strategic goals (Goodley, 2011). 6.0 Conclusion The purpose of corporate governance is to facilitate effective management for the long-term success of the company. The Code guides the organization based on the underlying principles of good governance. However, Tesco has a total economic approach to governance where focus for value creation is aimed at maximizing the shareholder value and not organizational value. The shareholders as well as the different stakeholders have been aggressive and to appease them in the short-run Tesco announces certain changes to the strategy. The Remuneration Committee has been behaving irresponsibly as executive remuneration has come under scrutiny and also caused upheaval among the shareholders. They do not have independent directors in the Corporate Responsibility Committee. The company does present its annual report and shows compliance with all the provisions of the UK Corporate Governance Code but it does not actually do so. In trying to violate the Code they are in fact losing the reputation they have build in these years. They are unable to recognize the opportunity they have to legitimize the position of the company in the society. They do not demonstrate responsible leadership as they have not taken the responsibility of achieving the bottom-line, towards the stakeholders and neither towards the integration of the multi-cultural workforce or towards the environment or the society at large. Tesco has neither been able to demonstrate transformational leadership not servant leadership. They demonstrate unethical leadership. The non-executive directors are unable to challenge the decision of the executive board members. Their responsibility ends with submitting their report to the board. Corporate governance at Tesco is weak as the focus is on minimizing the agency costs in the interests of the shareholders. 7.0 Recommendations The Board has to think deeply and this should be an ongoing process. Withdrawing incentives merely to appease the shareholders and simultaneously providing incentives by way of bonus for special efforts is not a sign of good governance. Risk management is not about compliance but performance. Ethical leadership may not always make sound commercial sense. What is required at Tesco is good leadership. Servant leadership at Tesco would be ideal as they need to attend to the moral needs of the followers. However, an ethical approach to business is essential. For instance, they need to change their sourcing strategies and stop exploitation of farmers and other suppliers. Stronger corporate accountability legislation could ensure that retailers such as Tesco deliver right reporting on their CSR activities. Tesco should enter into a deeper and more complex set of social relationships of the corporation that a single focus on the shareholders. Building social capital requires a new set of skills and investments. They should have transparency in all their dealings and decisions and be accountable for their actions. To maintain better relations with their employees and to maximize performance, leaders at Tesco should follow the servant leadership principle. References Catherine, M., 2008. Business executives' perceptions of ethical leadership and its development: Implications for higher education and human resource development. ProQuest Dissertations and Theses CIMA. 2004. Enterprise Governance Getting the Balance Right. Professional Accountants in Business Committee (PAIB) of IFAC. Clarke, T., 2004. Theories of corporate governance: the philosophical foundations of corporate governance. [e-book] Routledge: Taylor & Francis Group. Available at: [Accessed 4 Feb. 2012] Creevy, J., 2011. 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Available at: [Accessed 5 Feb. 2012] United Food and Commercial Workers International Union, 2008. The Two faces of Tesco. [pdf] Available at: [Accessed 5 Feb. 2012] Whiteaker, J., 2010. Rights disparity for Tesco’s US workers. Retail Gazette. 2 Sept. [online] (Last updated 11.47 AM 2nd Sept 2010) Available at: [Accessed 5 Feb. 2012] Wills, K.W.M., 2011. Seven Positions on Social Responsibility. [online] 4 July. Available at: [Accessed 5 Feb. 2012] Appendix A Source: IRM (2011). Appendix B Source: Sachs, Rühil & Mittnacht, 2005 Read More