Reference no: EM131340262

Good ethics means more than ticking boxes
Corporate governance codes have proliferated and business ethics is a fast-growing industry. But has corporate behaviour changed? The scandals just keep coming: Citigroup, AIG, Volkswagen and SK Corp have all had to defend themselves against allegations of ethical misconduct in recent months. Meanwhile, boardroom pay and golden goodbyes continue to escalate far beyond any corresponding improvement in corporate performance. The actors may have learnt their cues better, but they appear to have lost the plot. Why is this? And what can and should be done about the serious ethical shortcomings in finance and business?

In an environment where much boardroom pay is in the form of equity or stock options, most scandals today involve cooking the books to keep the share price up. Add in the fact that chief executives are under greater pressure than ever before from fund managers and analysts to ‘hit the numbers' and you have the nub of the problem. Incentive structures in the boardroom and below, and the business strategies of the consultants, all push in a direction that is at odds with ethical behaviour and, it should be said, long-run corporate performance. Ordinary financial market participants and business people feel penalised, not supported, for raising ethical questions.

This misalignment between individual incentives and ethical behaviour is not adequately addressed by the Sarbanes-Oxley Act in the US. Its requirement for companies to have a code of ethics for the CEO and the chief financial officer assumes that you can legislate companies into good behaviour. Conversely, the extraordinary expansion of legislation and governance codes since Enron has exacerbated the problem by encouraging a compliance culture.

Ethics and governance are today reduced to a box ticking exercise, while many codes are cynical public relations exercises. Too many boards have delegated the task to ethics officers, who in turn have outsourced the task of defining the company's values to consultants. These ‘values' are then ignored by directors and employees as meaningless puff. Cynicism is not universal. But even where ethics are taken seriously, the rate of corporate change, with takeovers, divestments and redundancies, makes it harder for employees to hold on to core values.

The law alone is not enough to ensure that corporate behaviour does not act against the wider interests of society. It invariably codifies the lowest common denominator, while lagging behind changes in the way the economy and markets evolve. And corporate activity has side-effects - externalities - that are not adequately regulated by the market or by laws and regulations.

So there is a need for ethical behaviour that goes beyond complying with the law, especially in the grey areas where managers face conflicting priorities. A further case for business ethics is that trust is fundamental to business relations and to the efficient working of markets. Economies contract when trust breaks down. The more transactions have to be governed by contract the more cumbersome and costly business becomes as everything has to be negotiated, agreed, litigated and enforced. Put crudely, ethical standards are a lowcost substitute for internal control within the company and for outside external regulation. While many financial participants grapple with new rules on operational, market and credit risks they should remember that ethics plays a role in risk-management at both the macro and micro level. The collapse of Andersen, Enron and WorldCom demonstrates what can happen when ethics go out of the window.

Restoring trust and establishing a more ethical corporate culture are therefore worthwhile objectives. That means addressing personal behaviour. But we should not forget the corporate incentives that lie behind that behaviour.

A MORI poll in the UK last year showed that, when prompted, only 42 per cent of institutional investors said they took into account honesty and integrity of corporate leaders in making investment decisions. When not prompted, this figure fell to 6 per cent. The shortterm bias of institutional investors may actually conspire to support unethical behaviour. Perhaps greater research and analysis is required to help investors measure unethical behaviour and weigh up its real long-term consequences. This is not a pipe dream. It is one of the objectives of the recently announced Enhanced Analytics Initiative of leading fund managers.

Meanwhile, it is important to remain focused on changing individual behaviour. After all, it is individuals who make unethical decisions, not faceless, corporate bodies. It is vital that managers engage employees throughout the company when they draw up ethical standards. A code handed down from on high, without consultation, will be treated with deserved scepticism. Managers must also convey the message that beating targets and winning business at any cost fly in the face of what the company is about. They should avoid the crass error perpetrated at Enron where people who violated the company's stated values were treated as heroes if the violation helped the bottom line. Managers also have to show by example that they do not expect employees to shed their moral values when they walk through the company door.

The attributes of ethical leadership, according to the London-based Institute of Business Ethics, are openness, fair-mindedness, courage, honesty and the ability to listen. It would be nice if all managers had these attributes - now that is a pipe dream - but more effective than an attractive personality is a sound framework to make ethical choices. We believe this is easier to do than it sounds. A simple starting point is for decision makers to query any business decision routinely, asking whether it will cause harm to anyone; whether the decision has been influenced by disguised conflicts; and whether a situation has been contrived that disadvantages others.

Those accused of perpetrating market timing abuses during the last stock market boom may have forgotten the first question. Those who puffed new issues to their clients deuring that boom failed to consider the second question. Citibank's European government bond traders probably failed to ask themselves the third question when they tried to corner the market in September 2004.

For some, a heavy judicial penalty is the only route to ensuring good behaviour. But for many in business, asking good questions is the starting point to making an ethical culture work.

Ethical Framework
The intricate ethical guidelines laid down in the Sarbanes-Oxley Act and elsewhere can relegate business ethics to a box-ticking exercise. We propose a simpler approach: the following five simple questions provide a minimum framework. Whatever the answers, if managers and employees are not even asking these simple questions you should expect a problem.

• Who are all the people affected by this business decision: from employees, shareholders, counter-parties and clients to the wider community and environment?

• Does this decision cause harm to any of those affected and are there reasonable things you can do to mitigate this harm?

• Is your behaviour deceptive? Would you regard it that way if you were in the counterparty's position? • Are there any disguised conflicts between yourself, shareholders and those affected by the business decision? Transparency can help reinforce ethical behaviour.

• What would happen if everyone were to behave in the same way in relation to each player in the transaction? This is like every driver at an intersection deciding to jump the traffic lights. If harm would be caused by everyone treating clients, counter-parties, whistle-blowers and shareholders as you do, you should refrain from doing it.

From ‘Good ethics means more than ticking boxes',

Avinash Persaud and John Plender, Financial Times, 23 August 2005

As the article indicates, the scandals just keep coming and the law alone is not enough to ensure that corporate behaviour does not act against the wider interests of society. What are the solutions to corporate misbehaviour in your view? Relate your arguments to your own country's ethical environment.