Chapter 18 Build a more ethical corporate culture

Codes of corporate governance are proliferating, and business ethics is a rapidly growing industry.But has corporate behavior changed?Scandals continue: Citigroup, AIG, Volkswagen and SK Corp have all had to defend themselves against allegations of wrongdoing in recent days.Meanwhile, corporate director compensation and expensive breakup packages to departing executives have continued unabated without any corresponding improvement in corporate performance.The actors got a better handle on the prompts, but they seemed to forget the plot.why?What can we do about serious financial and business moral flaws?What should be done?

In an environment where many corporate boards are now compensated in the form of stock or stock options, most corporate scandals involve cheating the books to keep stock prices going up.Plus, CEOs are under unprecedented pressure from fund managers and analysts to "get to the numbers," which is the crux of the matter.The incentive structure of the board and subordinate departments, as well as the business strategy of the consulting firm, all make the company's development contrary to the direction of ethical behavior and, it must be noted, the direction of the company's long-term performance.Ordinary financial market participants and business people feel they will be punished, not supported, when they raise ethical issues.

In the US, the Sarbanes-Oxley Act did not adequately address this mismatch between personal incentives and ethical behaviour.The act requires companies to have a code of ethics for their CEOs and CFOs, taking it for granted that companies can be legislated to play by the rules.Instead, the proliferation of legislation and governance norms since Enron has encouraged companies to build a culture of compliance, making the problem worse. Today, ethics and governance have been reduced to an exercise in ticking boxes, and many codes have become cynical PR tasks.Too many boards delegate this task to corporate ethics officers, who in turn outsource the task of defining company values ​​to consulting firms.These "values" were then dismissed by company directors and employees as pointless boasting.While not every company is so cynical, even those that take ethics seriously can have a hard time keeping employees committed to core values ​​because of the corporate changes that mergers, divestitures and layoffs can bring.

The law alone is not enough to ensure that corporate actions do not run counter to wider social interests.Compared with the changes in the economy and the market, the general norms that are always the minimum requirements determined by the law are still lagging behind.Moreover, corporate activities have external side effects, which are still not fully regulated by the market and laws and regulations.So we need a layer of ethical behavior that goes beyond the law, especially in those gray areas where managers face dilemmas. Another deeper reason for business ethics is that trust is fundamental to business relationships and the efficient functioning of markets.When trust collapses, the economy shrinks.The more transactions that are bound by contracts, the more cumbersome and costly the business process becomes, because everything has to be negotiated to reach an agreement, and legal procedures must be introduced and enforced.Put simply, ethical standards are a low-cost alternative to internal corporate controls and external regulation.Today, as many in finance struggle to adapt to new rules about operations, markets, and credit risk, they should remember that ethics play a role in risk management at both the macro and micro levels.The bankruptcy of Andersen, Enron and WorldCom all showed what can happen when morality is gone.

That's why restoring trust and building a more ethical business culture is a worthy goal.This means regulating individual behavior, but let's not forget the corporate incentives behind individual behavior. Last year, a survey by MORI in the UK found that only 42% of institutional investors, when prompted, said they looked at the honesty and integrity of business leaders when making investment decisions; that number dropped when there was no prompt to 6%. The myopic tendencies of institutional investors may actually encourage unethical corporate behavior.Perhaps we need broader research and analysis to help investors measure unethical behavior and assess its long-term consequences.This is not a pipe dream, but one of the goals of the recently announced Enhanced Analytics Initiative by some of the industry's leading fund managers.

At the same time, it is still important that we focus on changing individual behavior.After all, it is individuals, not invisible corporate entities, who make unethical decisions.When managers set ethical standards, it is critical to involve all employees throughout the organization.If an ethical standard is passed down from the top without discussion, it should be questioned by employees.Managers must also make it clear that doing whatever it takes to achieve goals and win business is a flagrant violation of the company's purpose.They should avoid repeating Enron's failure to treat the person who violated the prescribed values ​​as a hero whenever a violation helped increase the company's bottom line.At the same time, managers must demonstrate by example that they don't want employees to forget about moral values ​​once they walk out the door.

According to the London-based Institute of Business Ethics, the qualities of an ethical leader are: candor, fairness, courage, honesty and a good listener.It would be great (a pipe dream) if all managers possessed these qualities.But even more effective than charisma is a reasonable, ethical framework for behaving.In our opinion, this is not as difficult as it sounds.A simple starting point is that decision makers should routinely ask questions about all business decisions, such as whether the decision would harm anyone, be influenced by some potential conflict of interest, or be designed against others.

Those who were accused of abusing market timing during the last stock market boom may have forgotten the first question.The people who bragged about IPOs to their clients during that stock market boom didn't think about the second question.When European government bond traders at Citibank tried to manipulate the market for profit in September 2004, they probably didn't ask themselves a third question. For some, the only way to ensure they behave is through harsh judicial punishment.But for most people in business, asking the right questions is the starting point for making an ethical culture truly effective.

The complexities of ethics mandated by Sarbanes-Oxley and other laws have the potential to reduce corporate ethics to a ticking box exercise.We recommend a simpler approach: the following five simple questions provide a minimum ethical framework.Whatever the answer, if managers and employees aren't even asking these simple questions, you're going to have a problem. ■Who will be affected by this business decision, from employees, shareholders, counterparties, customers, to the wider society and environment? ■Will this decision harm anyone affected?Can you do something reasonable to lessen the damage?

■ Is your behavior deceptive?If you were on the other side of the transaction, would you think so? ■Are there any potential conflicts of interest between yourself, the shareholders and those affected by the business decision?Increased transparency helps strengthen ethical behaviour. ■ What happens if all parties in a transaction behave in the same way as each other?It's like the situation where every driver decides to run a red light at an intersection.If everyone is hurting customers, counterparties, whistleblowers and shareholders as much as you are, you shouldn't be doing it.