Five Questions That Corporate Directors Should Ask

by Larry Colero, Crossroads Programs Inc.

One of the most lethal threats to any organization is misconduct within its own walls. We need only consider the sudden demise of Enron Corporation or Barings Bank – both fatally wounded by their own officers. Lack of attention to ethics can be a corporation’s Achilles’ heel, with the potential for a single employee to topple even large well-established companies. Adding to the threat, advanced technology gives individuals more power, raises the stakes and speeds up the action.

This is why there’s no reassurance in stating that recent scandals like Enron, Xerox or WorldCom are aberrations rather than reflections of a systemic problem. Whether or not the majority of companies actually have these problems, they are all highly vulnerable under the wrong circumstances.

This paper presents five questions any board member can ask to begin a dialogue that will mitigate the risks presented by principle-agent relationships in larger organizations. But before we get to the actual questions, let’s consider why they need to be asked.

Why does this concern the board?

Directors are essentially ‘guardians’ of a firm, charged with overseeing management to ensure that a firm’s business is conducted with a sound strategy and prudence. More than just maximizing return on investment, good governance demands that directors do everything in their power to protect shareholders’ assets.

Assuring the management of ethics is an important function of the board for the following reasons:

The board is ultimately accountable for corruption or impropriety in a company.  Chairs have been asked to resign as a result of staff indiscretions. Some have been fined or imprisoned for their complicity in approving policies that encouraged misconduct.

Research indicates that corporate systems (e.g., incentive systems, hierarchies, and so on) often breed misconduct. Messages implied by the board’s decisions on resource allocation, performance targets or promotions will always trump official statements of ethical values.

Generally, staff know more than auditors about what is really going on. Yet most corporate whistleblowers are given little or no protection if they choose to challenge dishonest management. For this and other good reasons, it’s unlikely that a staff member would ever approach the board directly with an ethical concern about senior management, compromising the board’s ability to ‘supervise’ management.

Many CEOs complain that they are prevented from managing ethics because of other business pressures. The board is in a key position to influence these ‘pressures.’

As a steward of the company’s interests, the board should insist upon the establishment of systems and structures designed to reduce ‘agency risks’ and nip problems in the bud.

 

Why isn’t ethics management part of a typical board agenda?

Ethical risks can be difficult to discuss, since they tend to be nebulous and somewhat theoretical (…until someone’s hand is caught in the till).  A well-intentioned discussion of ethics can quickly be reduced to platitudes and moralizing by those who are unfamiliar or uncomfortable with the subject.  This is an effective way to shut down dialogue and avoid taking action.

For example, a CEO assures the board that the firm’s business is conducted “with the highest standard of integrity.”  Sounds good, but what exactly does that mean?  And how can a director question the meaning of such a lofty statement without insulting the CEO?

No matter how trustworthy, ethical or well-intentioned your CEO may be, it is naive and bordering on negligent to accept their word at face value when they tell you that the company’s ethics are in good shape.  Directors have a responsibility to pursue corporate ethics ‘below the surface.’ A reasonable CEO should understand this.

Yet even the best will misconstrue enquiries as a personal affront. Take for example a highly moral and trustworthy executive. They may well respond to the question defensively, instinctively declaring it a non-issue and giving full assurance that they and their management team are above reproach.  In this case, that’s true. The problem is that a lying, cheating, thieving executive would respond exactly the same way!  After all, con artists are experts at generating confidence.

Clearly there’s a need to pursue ethics beyond verbal assurances.  But how can a board do this in a meaningful way without looking suspicious, or meddling in the day-to-day affairs of the business? There are various mechanisms such as internal or external auditors, risk management committees, and so on. Each has its benefits and inadequacies.

For the individual board member, it’s a question of diplomatic assertiveness. As with other topics at the board table, directors should start by asking a few open-ended questions and continue asking until they are satisfied with the answers.

With regard to ethics management, try the following questions as starters:

Question #1:
What is our company’s strategy to manage ethics?

Can someone describe the company’s approach to ethics other than in broad philosophical terms? Where does ethics fit into the overall strategy? What are the moral implications of other strategic initiatives? (For example, incentive programs frequently provide motives for misconduct, and may need to be revised or balanced.)  Was ethics management discussed at the last board retreat or strategic planning session?

What systems are currently in place to foster and monitor ethical behaviour?  How effective are they?  Is there any documentation to back up implementation? What are the company’s objectives for the coming year(s) with regard to ethics management?

Question #2:
Who is responsible for ethics in our company?

The answer “everyone,” while literally true, is not satisfactory. Unless your company is one of the few with a designated ethics officer, the accountability for managing ethics can bounce back and forth across disciplines and up and down the hierarchy of most companies like a hot potato, never landing anywhere.

In many companies the responsibility for ethics management is delegated to board committees, Human Resource or Compliance functions.  Larger, more sophisticated firms appoint Ethics Officers.  It helps to have a central focus for ethics that is clearly accountable and well known in the organization.

Question #3:
Are people in our firm equipped to recognize and resolve moral dilemmas?

Can the employees recognize ethical issues as they arise?  An ethical problem can’t be resolved unless it’s first acknowledged as a dilemma.  Ethical issues can build slowly like the ‘thin edge of a wedge’ or pass by so quickly that they are only seen in hindsight. What guidance does your company provide for employees who face ethical dilemmas?

As well, employees come from diverse cultural backgrounds, each with their own moral standards. (For a multicultural ‘dilemma detector’ see the paper A Framework for Universal Principles of Ethics.) Do your people need help understanding the company’s moral expectations?  Is there a code?  Training?  Ethics advisory service?

Question #4:
Are people in our organization provided with a safe opportunity to discuss ethical issues of concern?

A 1992 survey of over 4,000 U.S. workers found nearly one third felt pressured by their companies to violate official policies in order to achieve business success.  Another third said that they had witnessed violations of ethics policies (such as stealing, lying to supervisors and falsifying records) but only half of these were willing to ‘blow the whistle.’ Conspiracies of silence place a company at significant risk, yet they are surprisingly commonplace and reasonably predictable.

Boards need to be satisfied that an effective reporting mechanism is in place to hold management and staff accountable, and bring wrongdoing to light before too much damage is done. What policies and systems are in place to protect ‘whistle blowers’?  Does your company have an Ombudsman, an Ethics Officer, or a Hot Line?  (Human Resource departments don’t count, and neither do so-called ‘open door’ policies or ‘progressive managers.’  It has to be safer than that, and less subject to hierarchical influence.)

Question #5:
Do we reward or punish ethical integrity and moral courage if it has a negative impact on the bottom line?

A 1990 study by Columbia University found that nearly half of 1,000 business executives surveyed admitted being rewarded for taking action on the job that they considered unethical.  One in three reported that refusing to take unethical action resulted in penalties.

An overemphasis on immediate gains can cascade down the organization, sending a strongly implied message to staff that cutting corners and generating cash flow supercedes all other objectives, including personal integrity.  Conveyed through subtle means, this message will always carry more weight than official proclamations of values, codes of ethics, and so on.

Consider what happens to someone in your firm when they stand up for ethical principles against the pressure of other business objectives.  Are they punished or praised?  If they’re praised, is there also some tangible reward? (Ask your CEO for some examples.) How do the rewards compare to the possible incentives for unethical action?  Compare a situation where someone cut ethical corners to make money, to another situation where an ethical principle was upheld at a significant bottom-line cost.  How did each play out?

 

Conclusion

It is comforting but dangerous to assume that there are adequate internal mechanisms to prevent, detect and report unethical conduct, or that moral assertions from the executive team need not be challenged.

To be proactive, corporate directors need to minimize a company’s ethical liabilities and maximize its ethical assets by:

recognizing the company’s need to manage corporate ethics, and the dangers of taking it for granted

supporting management to prevent or protect against unethical activities

developing strategies to raise the ethical standard in the organization and build trust as a competitive advantage.

 

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