Spotlight on corporate ethical behaviour

They say a fish rots from the head, and the boards of large corporations rightly come under scrutiny when the actions of those under their leadership are revealed to be less than wholesome. Companies including Volkswagen, Wells Fargo, United Airlines and Uber have all hit the headlines recently with commentators questioning the ethical standards of practice shown at levels from front line staff through to boards of directors.

The scandals drawing attention are often not the actions of one bad apple. Take for example the more than 5000 staff dismissed as a result of the fraudulent activity at Wells Fargo, or the million plus vehicles fitted with defective emissions testing devices by Volkswagen. There are clear signals something is not right with the ethical standards set by the board when this many people are involved in such activity.

Worryingly, the boards of these companies were quick to distance themselves from the actions of staff in the organisations they head; either directly placing the blame on senior management or failing to recognise the role the board had played in the outcome.

Discussing a report on the investigation into the activities at Wells Fargo, where more than 5000 staff members were found to have opened false accounts to boost sales, the LA Times notes that the board essentially blamed senior management for failing to provide accurate information about what was going on. The Times understandably dismisses this excuse:

Sorry, that won’t do. A careful reading of the report reveals a board that took months, even years, to get its arms around the scandal despite plenty of warnings about its nature and magnitude. These include an investigation by The Times in December 2013 and a lawsuit filed by Los Angeles City Atty. Mike Feuer in May 2015.

To claim that management did not properly brief the board is a poor excuse – the board needs to have confidence in the information management provides. Fortune notes the lack of responsibility taken by the board is demonstrative of a wider issue. The report also ignored the board’s failure to address whistleblower cases. In doing so Wells Fargo missed an important opportunity to “signal a new culture of openness and shared accountability, rather than retaliation. Instead, the report strongly suggests that an emphasis on blame will continue to permeate the culture as long as the current board rules.”

The Times summarises that the scandal and lack of responsibility taken by the board isn’t unique, noting “almost any corporate scandal can be traced to some degree to a board unwilling or unable to perform its function of riding herd on management.”

Writing for Project Syndicate, Professor of Leadership and Governance at IE Business School, Lucy Marcus, says that trouble at governance level is one rarely publically discussed as a cause of large corporate failings. Of the risks highlighted in the World Economic Forums’ 2016 Global Risk Report, Marcus argued none caused “the recent spike in debt crises or the wave of scandals that engulfed – just in the last year – Volkswagen, Toshiba, Valeant, and FIFA. These developments (and many more) are rooted in a more pedestrian – and perennial – problem: the inability or refusal to recognise the need for course correction (including new management).”

Can a leopard change its spots?

In October 2015 the Financial Times asked whether Volkswagen’s decision to nominate a long-serving executive as chairman again highlighted the carmaker’s corporate governance and culture, which some experts argue were a root cause of the diesel-emissions scandal:

VW has admitted installing software in engines over several years so they passed laboratory emission tests but belched out dangerous nitrogen oxides when on the road...Governance experts argue the cheating was predictable because of VW’s lax boardroom culture and peculiar corporate culture. “The scandal clearly also has to do with structural issues at VW…There have been warning about VW’s corporate governance for years, but they didn’t take it to heart and now you see the result,” says Alexander Juschus, director at IVOX, the German proxy adviser.

At a meeting in 2016 Volkswagen CEO Matthias Müller told shareholders the scandal could prove to be beneficial for VW, should they manage to turn the crisis into an opportunity: “The crisis has also opened doors. It forced us to strengthen and speed up overdue changes, and to set new priorities… What unites all of us with a role to play here at Volkswagen… is the desire to do everything we can to win back trust.”

The Financial Times article notes however, that previous crises at VW – including a prostitutes and bribery scandal in 2006 – did not deliver real reform. Mr Juschus commented in the piece “if VW doesn’t change now then they will never do it. It really depends on the three big shareholders – whether they are willing to reform. I have my doubts.”

Carved in stone

Arguably what has happened at both Wells Fargo and Volkswagen is a question of ethics. Setting ethical standards of practice and a building a culture that values employees doing the right thing is not just a matter of writing out a few company values. You can carve your values into marble, à la Enron, but that won’t mean the company lives by those.

If the main concern of the business is to improve the bottom line does that mean those within your organisation can do whatever it takes to achieve that goal – fraud included? It isn’t a good look for a public relations stand point, but will ethical issues be addressed if the bottom line is not heavily impacted by unethical behaviour? Wells Fargo has not lost nearly so many customers as anticipated as a result its scandal. Volkswagen is enjoying increased sales, recently overtaking Toyota to become the top-selling vehicle brand; sales in China are high - according to the Guardian ‘dieselgate’ was a ‘non-issue’ there.

Even as bribery and corruption scandal envelopes top executives at Samsung, the company continues to enjoy high profits, in April posting its best quarterly profit in three years. Bloomberg reports the scandal, involving South Korean president Park Geun-hye, spurred millions of South Koreans to take to the street in protest “over cosy ties between the government and the family-run chaebol[1] that control much of the country’s corporate landscape.” That seems to be more of an action against government than of corporate governance issues.

Fortune magazine considers the varied responses from Samsung stakeholders:

Needless to say, investors won’t be happy if the scandal ends up hurting sales and public confidence in the company, but bear in mind that many consumers might not even be aware of allegations against the company. If you use a Samsung device, have you switched brands after reading about its bribery accusations? For many consumers, the answer is no.

Samsung investors and consumers will react differently. Investors who are aware and outraged by the charges are likely to consider investing elsewhere. Consumers, on the other hand, even if they are aware of the charges, will likely stay with the company, as long as their devices continue to work properly.

The Financial Times noted in April that after the nightmarish episode involving a passenger being violently hauled off a United Airlines flight, the airline’s shares were down just 5%:

In the volatile airline sector, though, this is a blip. It has barely underperformed its competitor Delta Air Lines over the period…Does this incident not show a brutal callousness toward the customer, reflecting a deeper cultural failing?

“What if even serious damage to corporate reputations is not, in many cases, very economically important in itself? …Where the consumer is happy to judge a company by the last product it turned out, the profit motive on its own makes a poor mechanism for keeping managers on the straight and narrow. Boards and regulators must step up.”

Taking a stand

Considering the behaviour of Uber CEO Travis Kalanick, a writer at Fastcompany (April 2017) pondered whether businesses actually take ethics into account:

“Businesses don’t have to be ethical, they only have to make bottom lines. It’s usually the government’s job to step in and prevent abuses that arise from vigorous tactics.”

A cynical point of view, but perhaps unsurprising considering the lack of trust reported in business in recent surveys such as the Edelman Trust Barometer. Is the message being sent that bottom line is the only consideration? That behaviour will not change unless shareholders demand it or the government steps in?

The IoD’s Four Pillars of Governance Best Practice notes there is a strong relationship between values and ethics in business. Directors are of course under pressure to deliver financial targets, but “focusing on ethical practice is not a diversion from core business… running a company with consistent integrity and high ethical values is simply good business.”

The benefits for an ethical business include attracting the best people and investment opportunities. Consumers can vote with their feet, and more and more investors are considering a wide range of values when deciding where to put their money. Speaking at a World Economic Forum event, Blackrock’s Barbara Novick noted there has been a huge shift in how the world sees companies and the boards responsible for them. Corporate governance issues are being elevated to front page news, not staying hidden away behind boardroom doors.

Investors have helped to push through change, engaging with businesses when they disagree with their values rather than just walking away. “Engage with companies on issues you have concerns about,” Novick says. “At the end of the day, the board members are there to protect the shareholders and they should be thinking about long-term.”

Shareholders will speak out. Wells Fargo’s board might not have taken responsibility for the issues in their organisation, but at the bank’s AGM in April, just 56% of shareholders backed board chair Stephen W. Sanger. The New York Times reported that five other directors failed to achieve a 70% vote “that typically denotes a serious protest vote and which often forces companies to respond on such matters as ‘say on pay.’ Not only does it suggest shareholders are displeased that board members were too slow to act, but also that the bank’s internal investigation into the years long affair was too soft on them.”

Dov Siedman, CEO of LRN USA, notes “when the world is bound together this tightly, everyone’s values and behaviour matter more than ever. … We’ve gone from connected to interconnected to ethically interdependent.”

Looking at what media says at any point in time can influence perceptions.

The tone from the top sets the culture of the entire organisation – the fish rots from the head.

Ethics and conduct advice to boards needs to improve

Boards have a key role in leading and overseeing ethics and conduct risk. This involves supporting management and holding them to account on achieving and maintaining a healthy organisational culture and ethical practices. However, our 2016 Director Sentiment Survey with ASB found that only 37% of boards receive comprehensive reporting from management about ethical matters and conduct incidents, and the actions taken to address them.

The repercussions from bad conduct can be devastating to a business, the emissions scandal at Volkswagen being a prime example. Boards need to ensure that management provide comprehensive and timely advice on ethical matters and conduct risks. Follow through from the board is critical to setting the right tone. How a board tackles its ethical issues can send a very clear signal to the CEO, senior management and the whole organisation.

Published in Boardroom Jun Jul 2017 issue