CHAPTER 4: CORPORATE CULTURE, GOVERNANCE AND ETHICAL LEADERSHIP

Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Define corporate culture Explain how corporate culture impacts ethical decision making Discuss the role of corporate leadership in establishing the culture Explain the differences between effective leaders and ethical leaders Discuss the role of mission statements and codes in creating an ethical

corporate culture Explain how various reporting mechanisms such as ethics hotlines and

ombudsmen can help Integrate ethics within a firm Discuss the role of assessment, monitoring, and auditing of the culture and

ethics program Explain how culture can be enforced via governmental regulation

4-2Copyright © 2014 by McGraw-Hill Education. All rights reserved.

In 2012, Greg Smith, executive director and head of Goldman Sachs’ U.S. equity derivatives business in Europe, the Middle East and Africa, resigned his position

This resignation was unusual because it was announced in a letter to the editor published in the New York Times in which Smith lambasted the corporate culture and leadership of Goldman Sachs

4-3Copyright © 2014 by McGraw-Hill Education. All rights reserved.

After 12 years at Goldman Sachs, Smith said, “I can honestly say that the environment now is as toxic and destructive as I have ever seen it.” Smith described a corporate culture in which the interests of

clients, the people Goldman Sachs was supposed to serve, were disregarded in favor of making ever-increasing profits for the firm

Managers asked not “What is good for the client?” but “How much money did we make off the client?”

Employees called clients “muppets” and spoke of “ripping off” clients with complex financial deals

4-4Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Smith faulted senior leadership, including the CEO and president, for the “decline of the firm’s moral fiber,” and for having lost a culture of integrity, trust, pride, and honesty Smith wrote that, instead, “The firm changed the way it

thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.”

4-5Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Smith ended his letter with the hope that his resignation would be a “wake-up call” for the Board of Directors and warned them that they would not survive if they lost the trust of clients

He concluded by advising them to “Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons .”

4-6Copyright © 2014 by McGraw-Hill Education. All rights reserved.

In a press release, Goldman’s CEO and president disputed Smith’s claims They argued that Smith’s letter failed to represent

“how the vast majority of people at Goldman Sachs think about the firm”

They noted that internal surveys suggest that nearly 90% of the company’s employees feel that the firm “provides exceptional service” to clients

4-7Copyright © 2014 by McGraw-Hill Education. All rights reserved.

As citizens we ask if business has any social responsibility beyond the economic ones of providing goods and services, jobs, and profits.

This chapter examines business from an internal perspective.

The classical model described in Chapter 3 treats ethical considerations as external constraints placed on business.

The Goldman Sachs case demonstrates that businesses do not always include social responsibility as an inherent element of their business models.

4-8Copyright © 2014 by McGraw-Hill Education. All rights reserved.

It is easy to emphasize individual responsibility for decisions, but these decisions do not exist in a vacuum.

Decision making will be influenced, even determined, by the corporate culture of the firm.

This chapter surveys some of the major issues around the development and management of a corporate culture, and the role of business leaders in creating and maintaining ethical cultures.

4-9Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Every organization has a culture. A culture is made by a shared pattern of beliefs, expectations, and

meanings that guide the behavior of its members. Businesses also have unspoken yet influential standards and

expectations. Some examples are dress codes, working hours, and also a firm’s values.

No culture is static. Cultures change, but modifying or having any impact on culture is

like moving an iceberg. One person cannot alter its course alone, but strong leaders can have a significant impact on a culture.

4-10Copyright © 2014 by McGraw-Hill Education. All rights reserved.

A firm’s culture can be its sustaining value. Culture can offer direction and stability in

challenging times, but can also constrain a firm to the common ways of managing issues.

The stability that is a benefit at one time can be a barrier to success at another time.

4-11Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Collins and Porras (1994) studied companies such as IBM, Johnson & Johnson, Hewlett Packard, Procter and Gamble, Wal-Mart, Merck, Motorola, Sony, Disney, General Electric, and Philip Morris, looking for common elements to explain these companies’ success.

The common element among successful companies was their core ideology, which is made up of core values and a clear corporate purpose. All these companies have strong corporate cultures and clear sets of values.

4-12Copyright © 2014 by McGraw-Hill Education. All rights reserved.

In situations where the law is an incomplete guide for ethical decision making, the corporate culture is likely to be the determining factor.

An ethical culture is one in which employees are empowered and expected to act in ethically responsible ways even when the law does not require it.

A corporate culture sets the norms and expectations that will determine which decisions get made.

An example of how cultures encourage some behaviors and discourage others is the two organizational approaches to relief efforts after Hurricane Katrina in September 2005.

4-13Copyright © 2014 by McGraw-Hill Education. All rights reserved.

FEMA and the Coast Guard responded differently following Hurricane Katrina.

Because of its bureaucratic hierarchical procedures, FEMA was unable to respond in a timely manner when the situation did not fit their usual rules.

FEMA Director Michael Brown was eventually removed and replaced with a Coast Guard admiral.

4-14Copyright © 2014 by McGraw-Hill Education. All rights reserved.

The U.S. Coast Guard has a reputation for being less bureaucratic. Their unofficial motto is “rescue first, and get permission later.” The Coast Guard empowers front-line individuals to solve problems without waiting for authorization.

While FEMA and the Coast Guard are similar organizations with similar missions, rules, and legal regulations, their cultures are very different, and their respective decisions reflect these cultures.

4-15Copyright © 2014 by McGraw-Hill Education. All rights reserved.

The cultivation of one’s habits, including the cultivation of ethical virtue, is greatly shaped by the culture in which one lives.

We are often as likely, or more likely, to act out of habit and based on our character, as to act based on careful deliberation.

Business institutions provide an environment in which habits are formed and virtues are created. Such an environment is an ethical corporate culture.

4-16Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Besides abstract considerations, an ethical culture can also have a direct practical impact on the bottom line.

Responsibility for creating and sustaining ethical corporate cultures lies with business leaders.

4-17Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Corporate cultures have great power to shape the individuals who work within them.

See Collins and Porras’ book, Built to Last: Successful Habits of Visionary Companies.

The person that you become, in your attitudes, values, expectations, mind-set, and habits, will be significantly determined by the organization in which you work.

4-18Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Corporate leaders must both advocate and model ethical behavior.

Leadership sets the tone not only via personal behavior, but also via allocating corporate resources to support and promote ethical behavior.

4-19Copyright © 2014 by McGraw-Hill Education. All rights reserved.

It is important in ethical leadership to be perceived as a people-oriented leader.

Even traditional leadership duties are perceived as being done within the context of an ethics agenda.

Ethical traits and behavior must be socially visible and understood (“walking the talk”) to have influence.

4-20Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Being a good or effective leader does not necessarily mean being an ethical leader.

Ken Lay and Jeffrey Skilling of Enron were good and effective business leaders, and were also unethical leaders.

4-21Copyright © 2014 by McGraw-Hill Education. All rights reserved.

One key difference between effective leaders and ethical leaders is the motivators used to achieve goals.

Threats, intimidation, harassment, and coercion can be used effectively, but modeling, persuasion, and use of one’s role in the company are ethical as well as effective.

4-22Copyright © 2014 by McGraw-Hill Education. All rights reserved.

An ethical style or method of leading, while central, is not sufficient to establishing ethical leadership.

The other element involves the goal or end toward which the leader leads.

4-23Copyright © 2014 by McGraw-Hill Education. All rights reserved.

There cannot be leaders or followers without a goal or direction.

Productivity, efficiency, and profitability are minimal goals.

4-24Copyright © 2014 by McGraw-Hill Education. All rights reserved.

An executive who makes a business productive, efficient, and profitable, and respects and empowers subordinates, may seem to be both effective and ethical at first glance.

But what if this executive’s business has unethical products – i.e., publishing child pornography, polluting the environment, or selling weapons to terrorists?

Socially responsible goals may be necessary for a leader to be fully ethical.

4-25Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Before impacting the culture via a code of conduct or statement of values, a firm must first determine its mission.

The Johnson & Johnson credo is an excellent example of a clear ethical mission statement.

4-26Copyright © 2014 by McGraw-Hill Education. All rights reserved.

After developing a mission statement, a code of conduct then can delineate this foundation more specifically.

The code of conduct can enhance corporate reputation.

The code can give concrete guidance for internal decision making, thus creating a built-in system for risk management.

4-27Copyright © 2014 by McGraw-Hill Education. All rights reserved.

After establishing corporate codes of conduct and mission statements, the second step in developing guiding principles for a firm is articulating a clear vision statement.

In addition to showing the firm’s direction, the vision shows how its members apply their values to their daily business practices.

4-28Copyright © 2014 by McGraw-Hill Education. All rights reserved.

After the mission statement and code of conduct, and the vision statement, the third step in the process is to identify how the cultural shift will occur.

You can’t simply “print, post and pray” (-- Stuart Gilman, President, Ethics Resource Center).

Implementation and follow-through are critical.

4-29Copyright © 2014 by McGraw-Hill Education. All rights reserved.

The final step in having an effective code that will influence the culture is a company-wide belief that this culture is attainable.

If conflicts prevent certain parts from being realized, or if key leadership is not on board, no one will have faith in the proposed changes.

4-30Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Critical to the success of any cultural shift are the following:

Integrating an ethical culture throughout the firm

Providing means for enforcement Means for enforcement includes allowing

employees to come forward with questions, concerns, and information about unethical behavior.

4-31Copyright © 2014 by McGraw-Hill Education. All rights reserved.

A key element of integration is communication. Without communication, there is no clarity of

purpose, priorities, or process. The Ethics & Policy Integration Centre claims

that communication patterns describe the company better than organization charts do.

4-32Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Reporting ethically suspect behavior is difficult. “Whistleblowing” can expose and end

unethical activities. Whistleblowing can also seem disloyal, harm

the business, and harm the whistleblower. Because reporting to external groups can be so

harmful, internal reporting mechanisms are preferable.

4-33Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Internal mechanisms for reporting wrongdoing, while preferable, must:

Be effective Allow anonymity Protect the rights of the accused Allow employees to report wrongdoing Create procedures for follow-up and

enforcement

4-34Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Internal mechanisms for reporting wrongdoing which have been created by many firms:

Responsibilities of ethics officers Responsibilities of compliance officers Ethics ombudsmen Ethics hotlines

4-35Copyright © 2014 by McGraw-Hill Education. All rights reserved.

If we cannot measure, assess, and monitor culture, it declines in importance.

Ongoing ethics audits allow companies to uncover silent vulnerabilities that could later pose challenges.

Ongoing audits serve as a vital element in risk assessment and prevention.

A firm’s management of its internal and external relationships is critical evidence of its values.

4-36Copyright © 2014 by McGraw-Hill Education. All rights reserved.

The United States Sentencing Commission (USSC) is an independent agency in the U. S. Judiciary.

The USSC was formed in 1984 to regulate sentencing policy in the federal court system.

Congress has been able to resolve disparity in sentencing via the USSC.

4-37Copyright © 2014 by McGraw-Hill Education. All rights reserved.

In 1987, the USSC prescribed Federal Sentencing Guidelines.

The guidelines apply to individual and organizational defendants in the federal system, bringing more uniformity and fairness to the system.

The USSC strived in its guidelines to create both a legal and an ethical corporate culture.

4-38Copyright © 2014 by McGraw-Hill Education. All rights reserved.

In recognition of the enormous impact of corporate culture on ethical decision making, the USSC updated its guidelines in 2004 to include not only references to compliance programs but to “ethics and compliance” programs.

The guidelines identify specific acts of a firm that serve as due diligence in preventing crime and the minimal requirements for an effective compliance and ethics program.

4-39Copyright © 2014 by McGraw-Hill Education. All rights reserved.

USSC’S Eight Minimum Requirements for an Effective Compliance and Ethics Program:

1. Establish compliance standards and procedures 2. Establish a governing body or board 3. Assign a specific high-level person to oversee

compliance, be responsible for day-to-day program operations, and report directly to the board

4. Use due care not to delegate important responsibilities to known high-risk persons

(cont’d.)

4-40Copyright © 2014 by McGraw-Hill Education. All rights reserved.

Summary of USSC’S Eight Minimum Requirements for an Effective Compliance and Ethics Program (cont’d.):

5. Communicate the program effectively to all employees and agents

6. Monitor and audit program operation for effectiveness; establish a safe way for employees and agents to report violations or seek guidance

7. Create an incentive and disincentive structure to encourage compliance and consistently discipline for violations

8. Respond promptly and appropriately to offenses and remedy program deficiencies

4-41Copyright © 2014 by McGraw-Hill Education. All rights reserved.

The concept of due diligence is a restless and flexible standard.

The standard reflects changes in daily events and changes in the ideas of potential wrongdoers.

A firm must learn from its mistakes and take steps to prevent recurrences.

A 1997 survey found that 47% of ethics officers reported the USSC’s guidelines to be influential on their firm’s commitment to ethics.

Another commission study found that the guidelines influenced 44.5% of ethics officers to enhance their existing compliance programs.

4-42Copyright © 2014 by McGraw-Hill Education. All rights reserved.