Over the long term, the credibility of an organization and the integrity of its leaders and decision-makers ultimately define its success or failure. The board of directors, the executive management team and other senior leaders have three responsibilities with respect to the organization’s code of conduct:
- Determine that the code is consistent with core values that the entity’s stakeholders will hold in the highest esteem.
- Ensure that they set the tone in complying with the code.
- Provide the appropriate oversight to ensure line-of-business leaders and functional managers are operating the business in a manner consistent with the code.
As they set the tone at the top, define a code of conduct and communicate, disclose, broaden and reinforce the code, directors and senior executives should keep an eye on the following warning signs:
The extent to which the code of conduct is emphasized and reinforced – There is little value to a code that is published but not regularly reinforced by management at all levels of the organization in company communications, onboarding activities, training and responses to code violations.
The manner in which management engages the board – Management’s relationship with the board could be a sign of how it engages its people. For example, consider the following warning signs:
- Management brings only good news and highly structured presentations to meetings with the board. Directors rarely hear bad news until it’s too late.
- Management only presents plans to the board for approval and rarely seeks input or advice as plans are being developed.
- The CEO controls the board’s agenda, board meetings are highly regimented and orchestrated and directors have little opportunity to discuss issues and concerns.
- Insufficient time is devoted to forward-looking strategic and policy issues on the board’s agenda.
- The CEO is combative and intractable when dealing with members of the board.
If a combination of these signs exist, are they an indicator of how management works with subordinates? Is it a sign that the CEO doesn’t really listen to his or her people? If so, does that behavior permeate the organization? Is this a sign that the organization could lose touch with reality in a rapidly changing global marketplace, if it hasn’t already?
Tolerance of a culture that could breed dysfunctional or illegal behavior – Unless effectively managed and balanced and put in proper perspective, past successes and growth – along with sustained pressures to achieve demanding performance goals – can breed a “warrior culture” and a cavalier attitude that spawns inappropriate behavior. For example, such behavior might include reckless risk-taking, unhealthy internal competition, institutional resistance to bad news, a dangerous lack of change readiness, variable compensation plans linked to unrealistic stretch sales and profit goals, a culture of arrogance and combativeness and a lack of focused attention to protecting the organization’s brand image.
If downsizing initiatives lead to middle managers having to do much more with a lot less – with no refinements to internal processes – and that result is ignored by management, important internal controls can be stripped away and employees can be tempted to “cut corners” and even act irresponsibly. If management is driven by unsustainable market expectations, the emphasis on managing earnings for short-term results can lead to generating sales or earnings at any cost, and even fraud.
In their annual report CEO letter for 2000, Enron’s two top leaders, Ken Lay and Jeff Skilling, wrote, “Enron is laser-focused on earnings per share.” Their emphasis on a single accounting measure for success is an integral part of the nexus that contributed to the fraudulent behavior that ultimately took down the company.
Evidence that senior management lacks credibility with employees – Such evidence might surface in employee surveys conducted by an independent consultant. It also can surface in other ways. Management may consistently make excuses for poor results, be unwilling to acknowledge errors in either strategy or execution or have a tendency to sweep away issues with a show of unbridled optimism. If the board notes that the CEO and executive management are unable to discern or are unwilling to admit when a strategy is not working or when execution of the strategy is obviously failing, it can safely bet that employees have noted it as well. A lack of management credibility within the organization can lead to serious issues, including the loss of vital talent needed to make the business work.
Evidence that certain business activities may be out of control – For example, is there direct or anecdotal evidence of a pattern of high-pressure sales practices, bullying negotiation tactics, disregard of regulatory mandates/authority, application of questionable accounting techniques or other similar activities to further the organization’s interests in questionable ways? If these conditions persist unabated, they may lead to illegal acts, brand erosion or other serious reputational problems down the road.
The identification of product or process failures and other problem areas – These matters may be a symptom of a potential ethics issue. For example, when a significant product or process failure occurs – resulting in massive product recalls, significant warranty costs, embarrassing supply chain disclosures, high-profile environmental disasters or other issues driving a high-persistence wave of reputation hits, is it a symptom of an ethical breakdown far upstream in the organization’s processes? If not, does it indicate a lack of clarity in priorities and conflicting metrics that, if addressed, might have helped mitigate the problem or even avoid it altogether?
For example, is there a culture deep in the organization in which cost and schedule targets trump public and environmental safety issues? If so, does the board of directors and CEO understand the conflict and the potential repercussions from a reputation management standpoint, as well as the need to clarify conflicting performance measures?
Requests to waive conflicts of interests or other significant ethics requirements – The board should pay close attention to requests from management to waive significant provisions of the code of conduct, including the immediate and long-term effects and unintended consequences if a waiver is granted. In some countries, such as the United States, such waivers must be disclosed.
Lack of follow-up on matters requiring attention – The board of directors needs to pay attention to the effectiveness of management’s follow-up on code violations and other noncompliance issues reported by whistleblowers and third parties. Is there evidence that management demonstrates a passive or complacent attitude toward financial reporting control deficiencies, process incongruities, customer complaints, lack of adherence to policies and procedures and other matters raised by whistleblowers, regulators and internal and external auditors? The identification and investigation of such matters, the conclusions reached and the remedies undertaken should be disclosed to the board or a designated committee of the board.
While the above red flags are not intended to be exhaustive, the board should consider whether they are indicative of integrity issues requiring attention in executive session. If there is one truism we can point to, it is this: Success achieved at any cost is not sustainable. A combination of the above indicators warrants investigation. Where there is smoke, there may be fire – if not now, then later.
Ultimately, the litmus test of the effectiveness of a code of conduct is whether it is practiced. When management’s preferences, value judgments and operating styles are consistent with the highest standards of ethical behavior, the organization is better positioned to sustain a high-quality reputation that attracts and retains the customer loyalty, talented employees and capital investment required to grow the business and create enterprise value. In every industry – with no exceptions – strong corporate ethics and responsible business behavior breed positive business results.
Using the above warning signs, the following key questions are offered for board members:
- Are you satisfied that the CEO and his or her direct reports emulate and practice the company’s code of conduct?
- Does the board’s oversight consider management’s communication, monitoring, reinforcement and enforcement of the company’s code of conduct? Does the board have its eye on the warning signs of dysfunction?
- When a significant product or process failure occurs, does the board consider whether the failure is a symptom of an ethical breakdown upstream in the organization’s processes or whether there is a lack of clarity in priorities or conflicting metrics that send mixed messages?
- Has the board considered its policies for evaluating requests by management for waivers of the code of conduct?
- Does the company operate in environments that might increase exposure to ethical violations and issues, e.g., operations in a country known for high corruption or a market niche that is struggling?
Below are additional questions for executive management to consider:
- Are you satisfied with the tone at the top set by the executive team? Are the right messages being sent? Do employees see clear evidence that the managers with whom they work are “walking the talk” with respect to the company’s code of conduct such that the tone in the middle is aligned with the tone at the top? How do you know?
- Is the code of conduct updated periodically for changes in laws, regulations, listing standards and the business environment?
- Is there an effective compliance infrastructure in place to reinforce the code of conduct, enforce and discipline violations of the code and ensure satisfactory follow-up to drive organizational learning from code violations?