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Reducing Corporate Misconduct

By Marc J. Epstein, PH.D., and Kirk O. Hanson
December 1, 2020

For decades, CEOs have made clear statements about the importance of acting more ethically and responsibly. There have been extensive changes in government regulations. Corporations have invested in mandatory corporate ethics training programs and hired chief ethics officers. And business schools have long been including ethics and corporate responsibility programs in their required curricula.

 

But it doesn’t seem to have made a difference. We still have as many corporate ethics violations as ever. In its various forms, corporate misconduct has imposed significant costs on individuals, communities, industries, economies, and on corporations themselves.

 

The two of us have spent most of our careers working on questions of business ethics and responsibility. We’ve been professors at several of the most prominent business schools in the world, including Harvard, Stanford, INSEAD, Rice, and Santa Clara University. We have advised dozens of major companies on the design of their corporate ethics and responsibility programs and on how to handle scandals that have occurred. We have given hundreds of speeches to students, executives, and the public.

 

Regretfully, we have to admit our efforts and those of so many others have failed to reduce the plague of repeated misconduct in the business world. We’ve taken a hard look at what we and a host of other individuals and institutions have done to address the problem, carefully examining what has been attempted to date—and why it has failed.

 

 

Our new book, Rotten: Why Corporate Misconduct Continues and What to Do About It (lanarkpress.com), examines in depth why corporations misbehave. We evaluate the thus-far-unsuccessful efforts of CEOs, boards, corporate ethics and compliance officers, business ethics professors, and a phalanx of consultants and critics. And we carefully examine recent cases of corporate misconduct (see “A Sample of Corporate Scandals, 2001-2020” for some examples). We conclude there are some things that can be done now to change the sorry record to date, but we believe that the way corporations and society view ethics, compliance, training, and responsibility must change dramatically.

 

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Too often, we hear that greed and misconduct are simply unchangeable features of capitalism—that people, the organizations, and the system are all corrupt. We think otherwise. Our decades of experience in working with companies, leaders, and students gives us some hope. We’re convinced that business ethics can be improved significantly through a radical reexamination, rethinking, and redesign of the way people and organizations approach the challenges of creating and sustaining corporate integrity.

 

CAN CORPORATE MISCONDUCT BE ELIMINATED?

 

If all of the efforts of business leaders, corporations, and business schools haven’t made a difference in improving the ethical and social performance of corporations, is there anything that can be done? We’re strongly convinced that the people, corporations, and economic system can work effectively to be ethical and responsible and just need a reframing and retrofit to succeed.

 

When it comes to ethical failures in business, three specific explanations are generally provided:

 

  1. Some people are bad. Many argue that the blame should be focused on the schools, families, and social institutions like churches and other places of worship that have failed at teaching the ethics necessary for responsible adults. Thus, there’s little that companies can do with employees who lack the required ethical foundations. We call this the Bad Apple theory.

 

  1. Some companies are bad. Others argue that it’s most often not the fault of the individual employees but rather of incentives, rewards, performance evaluation, governance, and control systems in organizations that permit and sometimes even encourage unethical behavior. We call this the Bad Barrel theory.

 

  1. The economic system itself is bad.Still others suggest that particular industries, geographies, or marketplaces are so corrupted that it’s difficult for ethical individuals or organizations to survive unless they adopt the corruption around them. We call this the Bad Orchard theory.

 

While we agree that there are indeed bad apples, bad barrels, and bad orchards in virtually every business sector, we argue that there are ways to manage each and improve corporate behavior—if each of us is ready to take a significantly different approach to doing so.

 

We don’t believe every corrupt action can be eliminated from business, but we’re convinced that the increasingly troubling problem of corporate misbehavior can be reined in and that capitalism can be harnessed to serve the common good more reliably.

 

10 INITIATIVES TO IMPROVE CORPORATE BEHAVIOR

 

Without a major rethinking of what’s needed, eye-opening corporate scandals will continue. There will always be pressures on and incentives for corporate leaders to act in ways that favor short-term profits over long-run sustainability. And there will always be the temptation to commit minor violations that put a company or an individual on a slippery slope that leads to more serious misconduct. Some executives will adopt clear ethical principles for their organizations, and others will reduce ethics to compliance, even blaming their own misconduct on poorly written laws and regulations.

 

We propose 10 initiatives that executives, boards, and companies need to adopt to create an organization that’s less likely to experience misconduct in the future. Some of these strategies are new, but others address how companies need to strengthen existing practices. (See “Immediate Actions to Better Manage Corporate Ethics.”)

 

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Companies may be quick to say they’re already doing all these things. But in our experience working with dozens of leading companies around the world, they typically aren’t—or at least they aren’t doing them well. Most corporate efforts are limited to the standard ethics and compliance practices. They’re also frequently poorly designed or implemented half-heartedly.

 

We are calling for a new approach involving leadership commitment among top executives and boards along with the necessary supporting systems and structures for effective implementation.

 

  1. Define and communicate a new approach to corporate purpose.

 

The Business Roundtable’s 2019 “Statement on the Purpose of a Corporation” shows the central weakness of corporate ethics efforts. The prevailing ambiguous commitments to “consider all stakeholders” allow companies to operate as usual without requiring any new actions.

 

The new definition of corporate purpose must explicitly state the social purpose along with other purposes and provide a plan for implementation. And it needs to be readily distributed and visible through internal and external communication channels.

 

  1. Create purpose-driven business strategies.

 

After adopting a clearly defined corporate purpose, it’s imperative to develop and assess business strategies that clearly and explicitly align with that purpose and its ethical commitments. Few companies have taken this step. Without directly connecting formal processes such as management control systems, structures, and procedures to the corporate social purpose, its goals won’t be achieved. All proposed business strategies must identify the risks that may frustrate the company’s stated social purpose or violate the rights or interests of one or more stakeholders.

 

  1. Set a new tone at the top through genuine moral leadership.

 

Most CEOs aren’t seen by their employees as the moral leaders they imagine themselves to be. The company that’s obsessed with growth and profit margins, and incidentally states that it wants integrity, is vulnerable to misconduct. In a large number of companies, the predominant view is that management is focused only on following the letter of the law—or merely on not getting caught. For instance, after the Wells Fargo crisis was disclosed, the CEO said that “the culture of the company is strong” and is “based on ethics and doing what’s right,” which led members of the U.S. Congress to suggest he was “tone-deaf” and “in denial.”

 

  1. Enhance line accountability for purpose and ethics.

 

Not much has been expected of line executives and mid-level managers in assuring that a company operates ethically. This needs to change. Often, the line manager is only asked if the organization has taken the required corporate ethics and compliance training. The executive or manager will only be penalized if the division or unit has a major scandal or if there’s a consistent pattern of violations or hotline reports. Real shared accountability for the purpose and ethics of the corporation requires much more.

 

  1. Expand the portfolio of the ethics and compliance officer to include “macro-ethics.”

 

“Macro-ethics” issues are the ethical dimensions of the major and minor strategic decisions the company makes, e.g., new products and markets, new financing instruments, mergers and acquisitions, and so on. These decisions often have significant ethics implications or risks, yet there often isn’t anyone at the table whose role is to raise those issues or suggest how to implement the decisions in ethical ways.

 

  1. Establish a transparent and safe environment for communication.

 

Company leaders must create an open and safe culture where employees can raise unresolved questions about the application of the purpose and goals to their own work and about directives given to them by supervisors and managers in their chain of command. Often, employees have concerns about a questionable directive they receive but feel compelled to suppress their ethical qualms for fear of angering their boss or even losing their job. Company nonretaliation policies are often of limited credibility to employees, who know there are many subtle ways to retaliate against an individual who raises a difficult ethical question to a supervisor or manager.

 

  1. Routinely evaluate incentives and systems based on core values.

 

Corporate leaders should ensure that every incentive program, system, and routine contributes to achieving the company’s purpose and ethical commitments. Goals should be challenging, but not so challenging that they encourage unethical behavior or inadvertently signal that employees are to meet the economic goals at any cost.

 

Formal systems and processes have the same risk: Their design may facilitate or frustrate the achievement of purpose and ethical behavior. Informal incentives also must be monitored very carefully. Enron, for example, was widely praised for years for its “outside the box” financial thinking, which eventually led to fraud and one of the largest bankruptcies in U.S. history.

 

  1. Develop techniques to anticipate ethics impacts and risks.

 

The achievement of social purpose and the management of ethical behavior in a company require a new approach to ethics risk analysis. Adopt formal ethics scanning to evaluate all proposed products, services, technologies, policies, and marketing campaigns. When companies fail to scan—or fail to act on what they learn—there are often overlooked ethical, legal, and financial responsibilities.

 

  1. Increase board accountability for corporate purpose and ethical behavior.

 

Many boards pay little attention to the corporation’s social purpose or ethical behavior. A new philosophy of board responsibility—having it responsible not just to the shareholders but to the corporate purpose itself—is now emerging. The most effective boards review and affirm the corporate purpose, management’s plans to balance that purpose with economic goals, and how management will create a culture that can serve all stakeholders.

 

  1. Reform existing ethics and compliance programs.

 

Corporate leaders must commit to the reform and improvement of their ineffective standard ethics and compliance practices. Ethics officers generally are aware of the weaknesses of their own programs, but their attempts to strengthen the programs are hampered by the preeminence of shareholder interests, the opposition of many line managers, and selective attention from most executive suites and boardrooms.

 

These programs are also constrained by a corporate attitude that they are merely cost centers, contributing little to the accomplishment of the company’s purpose. As a result, companies are often guilty of gross underinvestment in programs to shape the ethical corporate culture. There are several specific ways practices must be changed to better reduce corporate misconduct, including:

 

  • Employee ethics and compliance training built on corporate purpose and detailed ethical commitments. The company’s purpose and ethical principles must be at the core of all ethics and compliance training.

 

  • Middle management ethics training. A new kind of ethics and compliance training must be provided to enable line executives and middle managers to deliver on accountability. They must be trained to translate the company’s purpose into detailed ethical commitments and clear goals for their individual units.

 

  • A new approach to hiring and onboarding. Companies have the opportunity to strengthen (or weaken) corporate culture through the hiring and onboarding processes. It’s critical to include considerations of values and integrity in hiring and onboarding. Better methods must be developed to screen for values and ethical strength, the ability to resist pressure, and incentives to do the wrong thing.

 

  • Addressing employee misconduct. When misconduct is discovered among current employees, the company must be decisive in putting the wrong doers on probation if they’re salvageable and terminating them if they aren’t. Companies need to develop the capacity to coach and to discipline employees. They can’t be perceived as tolerating bad apples, no matter the individual’s status or economic contribution to the company.

 

TOOLS FOR EVALUATING ETHICAL RISK AND PERFORMANCE

 

The evaluation of ethics risk is becoming a core skill for any successful company. We have developed three tools (described in detail in Rotten) that help us predict whether a company we’re about to work for, do business with, or invest in is prone to misconduct or will engage in bad behavior:

 

  1. The Ethical Performance Audit is a backward-looking evaluation of a company’s past ethical performance and capability, assessing its record of ethical performance in the past as well as the strength of current efforts to manage ethical behavior. To conduct an ethical performance audit, management or an outside consultant examines three important components: the measures of past and current ethical and social performance, the strength of corporate culture and systems, and the attitudes and opinions of the employees as well as their reports of ethics problems.

 

  1. The Ethical Risk Audit takes past performance and current capability into account to assess the risk of future ethical violations. It evaluates whether the company is crisis-prone or crisis-prepared. As a part of both improving corporate conduct and reducing corporate ethical risk, an examination of the red flags is often very helpful (see “Red Flags of a Critical Ethics Risk”).
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  1. The Sin-dex helps with the processes of looking back and looking forward. It examines both past and potential future issues and activities to measure their severity and impact on the company’s various stakeholders. A rating of 0-10 is used to evaluate any incident on (1) the likely impact of actual or potential damage and (2) the degree of intentionality that motivated the behavior.

 

These three tools are immediately useful for companies that want to improve their management of ethics and compliance and reduce their risk of misconduct. The tools can highlight areas of ethical performance that need to be strengthened and help track improvement over time. They can also identify the riskiness of new areas of business and new strategies being pursued.

 

Just as we use them ourselves, these tools are useful for others as well. For instance, investors have a significant stake in the ethical performance and capabilities of the companies in their portfolios. Incidents of misconduct can impact stock price, weaken the confidence of employees and other stakeholders in the company, lead to a drop in sales, and make government permits and approvals harder to obtain. And there’s increasing evidence that employees (current and potential) are taking a company’s values and ethical commitments and record into account when seeking employment.

 

WHAT FINANCIAL LEADERS CAN DO

 

As business school professors and corporate consultants, we understand well the need to sustain and improve corporate profitability. But the persistence of corporate misconduct leads us to conclude that companies are badly underinvesting in their own ethics programs. CEOs are mistaken if they think that merely making a token statement or even a strong proclamation on the importance of ethics will make a difference. An entirely new approach is needed.

 

Corporate leaders generally—and financial executives in particular—should be sensitive to designing systems that encourage ethical behavior and discourage or constrain unethical behavior. But when violations do occur, immediate and decisive action must be taken.

 

It’s critical that financial executives use their seat at the table to implement corporate systems, incentives, corporate governance, and management controls to improve corporate conduct. The red flags should be top of mind for financial executives as they develop the appropriate governance mechanisms to reduce corporate exposure to corporate misconduct and violations. Though all employees have responsibility to avoid the dangers of corporate misbehavior, financial executives have it as a part of their primary responsibilities. By reducing ethical risk and improving corporate ethical performance, they can also make a major contribution to improving corporate financial performance.

 

Marc J. Epstein, Ph.D., was, until recently, a full-time business professor (Rice, Harvard, Stanford, INSEAD) and is the author of more than 20 books and 200 articles as well as a speaker and advisor to leading organizations globally. He’s a member of IMA’s Boston Chapter. Marc can be reached at epstein@rice.edu.
Kirk O. Hanson recently stepped down as the John Courtney Murray S.J. University Professor and executive director at the Markkula Center for Applied Ethics, Santa Clara University. He previously taught for 23 years at the Stanford Business School. Kirk can be reached at kohanson@scu.edu.
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