Business & Professional Ethics

Sessions 5 & 6 Ethical Governance Developing a Culture of Integrity

MMPA Program, 2011 Prof. L.J. Brooks Rotman School of Management, University of Toronto

CORPORATE GOVERNANCE FRAMEWORK

Shareholders Stakeholders Key Board Control Functions:
Set Guidance and Boundaries - Policies, Codes, Culture Set Direction - Strategies, Goals, Remuneration, Incentives Appoints CEO, who appoints other executives, and CFO Arrange for Resources Monitor Feedback - Operations, Policy Compliance, Financial Reports Reports to Shareholders, Govern. Nominates/decides on Auditor

Elect Board of Directors & Subcommittees:

Audit, Governance, Compensation

Auditor
Legend: Info Flow Actions

Board Responsibility for Corporate Actions: Legally to shareholders - Strategically to other stakeholders
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Board of Directors Responsibility

Legally SHAREHOLDERS

BOARD

Strategically

OTHER STAKEHOLDERS

How should the Board discharge its responsibility? What are the red flags that should be watched for?
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Global Business Ethics Value Chain

CORPORATION Governance Mechanism Formulation of Strategic Objectives
ACTIONS

STAKEHOLDER SCREEN

ACHEIVEMENT OF STRATEGIC OBJECTIVES

BEHAVIOUR

Customers INFLUENCES Employees Capital Markets Primary Current: Shareholders Lenders Environmentalists Other Host Communities Governments NGOs Media

GO CAUTION STOP

DETERMINANTS OF VALUESuccess = f(Trust + Respect)

CORPORATE CULTURE ETHICS PROGRAM &CODE TOP MANAGEMENT SUPPORT STAKEHOLDER SYNERGIES CHARACTER GLOBAL MEDIA PERCEPTION OF: TRUST RESPECT RELATIVE IMPACT RELATIVE SALIENCE LOCAL CULTURE
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Key Lessons from Recent Disasters

Mindset problems
Rationalization Did nothing wrong, no victim Values deficiency fairness, integrity, virtues expected Priorities self, profit, legality, others?

Governance flaws
No whistleblower encouragement program No checks on opportunism just too much trust/neglect

Self-interest & regulation are not enough

Need ethical corporate culture/culture of integrity

Reputation lost
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Curriculums are Changing

AACSB Ethics Curriculum Themes Per AACSB Ethics Education Task Force Report, June 2004
Corporate Governance

Reinforcement
by Business School Policies Guidance Application Enforcement Ethical Decision Making

Ethical Leadership Responsibility of Business In Society

L.J. Brooks 2005

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A Culture of Integrity can help remedy deficiencies

Corporate Culture those shared beliefs, values, and other means that guide the actions of a corporations employees and agents. A Culture of Integrity depends upon the set of beliefs and values that drive norms and actions.
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Organizational Culture the values, beliefs, norms, & practices shared by an organizations members
Mindset
Motivation
Must manage better

Norms

Values

Beliefs

Action

Identification & Communication

Code, Guidelines, Reinforcement

Monitor, Reward, Punishment

Must add expectations for motivation & rationalization

2007 L.J. Brooks, Business & Professional Ethics for Directors, Executives & Accountants, Thomson South-Western

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ORGANIZATIONAL CULTURE, INDIVIDUAL/TEAM OUTCOMES, & ORGANIZATIONAL EFFECTIVENESS

Elements of Organizational Culture
Assumptions Values Narratives Symbols Heroes Rites, Ceremonies,Rituals

Individual/Team Outcomes Job/Career Satisfaction Organizational Identification Job Involvement Commitment Discretionary Effort Job Performance

Reinforcers of Organizational Culture

Mission/Vision Leadership skills Growth/Development Opportunities Team Development Communication Performance Management Systems Incentives and Rewards Human Resource Systems

Organizational Effectiveness First Level Attendance Turnover Productivity Work Quality Recruiting Success Second Level Creativity/ Innovation Problem Solving Team Cohesiveness & Communication Third Level Market Share Profitability Achievement of Formal Org. Goals
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A Model of the Impact of Organizational Culture on Individual/Team Outcomes and Organizational Effectiveness , The Business Case for Culture Change, W. Reschke & R. Aldag, Center for Organizational Effectiveness, August 2000 .

Business & Professional Ethics

A Culture of Integrity/Ethical Culture is essential for:

The enthusiastic support of some employees, customers, and other stakeholders. Guidance about values or integrity expectations:
When to adhere to the corporate code. How to make decisions that protect the companys reputation and further its strategic objectives.

Sound risk management. Meeting governance expectations/requirements.

Good ethics, good reputation, good business, competitive advantage
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Evidence a culture of integrity can really help

KPMGs Ethics Survey, 2005-2006 an ethics program improves perceptions or behavior, as follows:
6-12% reduction in observed misconduct or violation of values and principles in the prior 12 months 9-16% improvement in prevention of misconduct 39-48% improvement in comfort in reporting misconduct to a supervisor 27-46% improvement in belief that appropriate action will follow reporting of misconduct 43-54% improvement in perception that CEO and other top executives set the right tone at the top 37-49% improvement in motivation to do the right thing
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THE FRAUD TRIANGLE

Motive

Rationalization

Opportunity
Source: D.L. Crumbley et al, 2005, p. 3-131
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MASLOWS HIERARCHY OF NEEDS

Self-actualization, Fulfillment
Esteem, Respect

Ego

Love, Affinity
Safety

Social

Physical
Physiological

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HEATHS SEVEN RATIONALIZATIONS OF UNETHICAL ACTIONS

Denial of responsibility. Denial of injury. Denial of the victim. Condemnation of the condemners. Appeal to higher loyalties. Everyone else is doing it. Entitlement.
Source: 7 Neutralization/Rationalization Techniques, a speech by Joseph Heath at the Centre for Ethics at the University of Toronto, April 9, 2007
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New Governance Expectations

Greater after Enron, AA, WorldCom
Need for Proactive Prevention of Problems better comprehensive risk management Accountability/Transparency to stakeholders Concern for Reputation Risk Need for strong ethical corporate culture Better understanding & management of corporate culture Better decision making
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New Board Responsibilities

Comprehensive Risk Management
Broad understanding of business model Financial literacy Guidance & Control framework Focus on corp. culture, ethics & reputation Business ethicswhistleblower protection plan Ethics Risk Management

Trust, but challenge, dont turn away

Caremark National Case, trend
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Comprehensive Risk Management depends upon the Corporate Ethical Culture

Comprehensive Risk Management utilizes both:
A. Key risk factor identification & measurement B. Review of key business processes including the ethical culture that underpins process integrity

Ethical culture provides guidance for employees about when to adhere to the Code, when actions are not covered in Code, in a grey area, or in a crisis - tools to measure ethical culture do exist Enrons Board failed to consider any of this! Few corporations do A, fewer do B!
L. Brooks
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Audit Committees Role is Key

Understand key business operations Understand comprehensive risk management model and reports Examine key/large transactions Ensure compliance with good policies Ensure fair presentation Who wants this risk? How much should the members be paid? Nortel Networks Audit Committee Case
L. Brooks
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How can good ethics and good governance be instituted?

1. Create an Ethics Program
Identify important values Build values into culture & decision making Train/Reinforce leaders must reinforce Monitor Performance Reward/Punish Re-evaluate values & ethics program

2. Create an Ethical Corporate Culture

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Ethics Program/Code Orientation Types

Orientation
Compliance-based

Primary Focus
Preventing, detecting, and punishing violations of the law Defines organizational values and encourages employee commitment Improvement of image with and relationships with external stakeholders (customers, the community, suppliers) CYA or cover your ___ Values and compliance-based, for example

Integrity or Values-based
Satisfaction of external stakeholders

Protect top management from blame Combinations of the above

__________________________________________________________________

Sources: Trevino, Weaver, Gibson and Toffler, Cal. Mgt. Rev., 1999, and Paine, HBR, 1994, 111; Badaracco & Webb, 1995, 15.

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Creating & Implementing an Ethical Corporate Culture

Create a Governance & Leadership Framework Develop the Core Values & Issues Foundation Create the Guidance Communications & Framework
Clarify Roles of Chair, CEO Chief Ethics Officer, Board Ethics Subcommittee Ethics Committee

Identify Core Values & Important Issues that should drive decisions & actions & ensure harmonization with strategy & operations

Develop Mission Statement, Code of Conduct & other Decision Aids & Processes

Develop Commitment & Understanding

Ensure Commitment by Board, CEO & Other Managers, Launch Ethics Program & Encourage Employees
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Corporate Culture Mechanisms

Cultural
Values, tone at the top, reinforcement...

Structural
Code, Ethics Officer, Program...

Procedural
Ethical decision making - ordinary + crisis mgt. Ethics inquiry... Internal Controls 20/60/20 Rule

Failsafe
Whistle blower protection...to BoardEnron, GE Ethics/values audit

To create an awareness of how we do things around here.

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Whistleblowers are essential

GE Whistleblower story: Boss & bosses boss overcharging Israel for jet fighter engines Gathered evidence for 4 years Sued for $70 million - False Claims Act US Government took case over Whistleblower can get up to 25% under FCA Settled for $59.5 + $9.5 mil. How much would you give W/B? Why? Whistleblowers to SEC recently got a raise 10% to 30% - July 21, 2010.
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Establishing an Ethical Corporate Culture The Leadership Component

Board of Directors, Governance Subcommittee, & Chair

CEO

ECC Champion Ethics Officer/ Ombudsperson Ethics Committee

CFO, Other Executives, Employees

Scandalized companies unethical leaders What defines an ethical leader? What should an ethical leader do?
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Executive Reputation & Ethical Leadership

MORAL PERSON
Weak Strong Ethical Leader

MORAL MANAGER

Strong

Hypocritical

Weak

Unethical Leader

Ethically Neutral Leader

Source: Moral Person and Moral Manager: How Executives Develop a Reputation for Ethical Leadership, L.K. Trevio et al, California Management Review, Vol. 42, No. 4, Summer 2000. Reprinted with permission.

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Establishing an Ethical Corporate Culture The Core Values & Issues Component
Core Values & Issues Identification & Articulation

Stakeholder Interests Analysis

Review of Frameworks Reputation Factors Hypernorms Ethical Decision Criteria Values Desirability Important Issues Identification Stakeholder Analysis Stakeholder Consultation Ethics Audit Expectation Gap Analysis Issue Ranking Ethics Risk Assessment

Integration into Strategic Objectives & Operational Goals

Communication

Reinforcement Mechanisms

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STAKEHOLDER INTERESTS RANKING, RISK ASSESSMENT & USAGE

SHAREHOLDERS + OTHER STAKEHOLDERS PUBLIC INTEREST
All Interests Accountability = Financial & Strategic including Ethical & Legal

CORPORATE RISK ASSESSMENT

Integrate Into Corporate Value System & Actions

BOARD OF DIRECTORS
Sets Vision, Mission, Strategy, Policies, Codes, Compliance, Feedback, Compensation

Identify All Stakeholders

Assess & Rank All Interests

Prepared by management for Board review and approval

Appoints CEO, CFO

Guidance

Feedback

CORPORATE CULTURE
Created by Management Leads to Corporate Actions

Actions

Motivation

Beliefs

Values

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Guidance - Codes of Conduct/Ethics

Primary guidance document Choices:
Imposed control vs. self-control Organizing focus
Stakeholder interests, strategic policies, issues Title & depth of focus
Credo, Code of Ethics/Conduct/Practice

Encouragement, commitment, monitoring

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Measure Governance: Why Bother?

If you cant measure it, you cant manage it Ethics/Corp. Social Performance (CSP) feedback Company objectives Personal objectives Reinforcement decisions Evaluation of management Compliance disclosures - environment, labor, ISO Stakeholder interest Creation of a competitive image Website: www.globalreporting.org for GRI initiative
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Key Governance & Ethics Qs

What do Ethics & Governance mean? Why are ethics and governance important? To whom are corporations accountable? Are Governance & Ethics related? Give examples of unethical acts & of poor governance. What are important governance mechanisms? Who is responsible for what? What role does corporate culture play? What caused the recent reform of ethics & governance expectations?

What are roles can an accountants play?

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Business Ethics & Professional Accountants Business Ethics

the moral standards that apply to business policies, institutions and business behaviour. Dealing with stakeholders
Identifying who, interests, priority Corporate social contract Stakeholder impact analysis
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Business Ethics Developments

Global ethical developments increase ethical expectations Accountability to stakeholders Business ethics value chain Reputation matters Whistleblowers matter Culture of integrity required

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