Benefits of Business Ethics and Cost and the Lack of It

Ethics is not important merely because the law says so. It is not just a question of legal compliance and you do need to care about the rest. In fact, letting stakeholders develop the perception that ethical behavior is not important to an organization will be incredibly damaging to its reputation and business prospects. More than just a public relation talk, a breach of ethics when exposed will result in wide range of negative direct and indirect consequences for an organization such as negative media coverage, regulator investigation, customer boycotts, reduced share price, drop in revenue and profitability, loss of key staff, even possibly criminal investigation and imprisonment for the executives involved. This, of course, applies equally for individuals, and there are plenty of cases of highly talented and successful individuals who were castigated because they violated ethical and legal requirements.

Conversely, good ethics is also good business. Treating stakeholders ethically will have direct impact on organizational performance by providing the following benefits:

• Build a solid reputation providing a differentiator edge in competitive markets.
• Attract consumers and have them buy products/services at a premium price.
• Attract investors and secure capital at a lower cost.
• Recruit and retain high-quality employees.
• Be recommended as a good partner.
• Nurture a positive relationship with regulators and the media.
• Provide protection against crisis by receiving the benefit of the doubt from loyal customers.

Anita Roddick, the founder of Body Shop is often cited (The New York Times, 2007), as an example of how doing good things is good for business. She has built a business model around developing quality beauty products that did not involve testing on animals and was the first to introduce “Fair Trade” to the cosmetic industry. By this strong ethical stance, she won the support of a growing number of more ethically and socially conscious customers.

The Emergence of the CSR Agenda: A New Moral Code of Conduct for Doing Business?

This leads us to another reason why business ethics is essential for business: the emergence of corporate social responsibility (CSR). CSR is about seriously considering the impact of an organization's activities on society. It requires organizations and their staff to consider the impact of their actions in terms of a whole natural and social system, and holds them responsible for the effects of their actions anywhere in that system. It could also be the impact on the natural environment or the communities living there.

In recent years business has been viewed increasingly as a major cause of social, environmental and economic problems. Organizations, especially commercial companies, are widely perceived to seek short-term profits for themselves at the expense of the broader community and future generations. It seems that in their pursuit of short-term profits, too many companies overlook the well-being of their customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell.

CSR proponents advocate that this narrow view of value creation prevailing in many companies seeking to optimize short-term financial performance while essentially ignoring the broader influences that determine their longer-term success is not sustainable. It will ultimately lead to the collapse of the companies following that model and tremendous cost to society as a whole.

Furthermore as the standards for ethical behavior continue to evolve and increase, your company's key stakeholders – shareholders, clients, employees and others, will increasingly expect you to meet or exceed those standards. This is true to various degrees in most industries today. While the value creation objective of organization is well understood and accepted, it cannot be achieved by ignoring basic ethical norms, values and standards of business practices. Companies get their “official” license to operate from the regulators, but also get an “unofficial” license to operate from their other stakeholders and the wider public. Therefore it is important for organizations to meet public expectations through proactive compliance with ethics codes, industry practices, and developing CSR-based business models.

How Unethical Behavior Can Happen in Organizations

Every day, managers are confronted with risks in any activities they undertake. And every day, they may have to make decisions about what they are going to do about those risks. Some of those decisions are simple while others can be particularly difficult to make. In the pursuit of short-term profits to achieve their bonus targets or for many other reasons, managers can sometime lose sight of what is right or wrong. Business ethics problems can involve any of the following issues (this list is not exhaustive):

• Bribery in the private and public sector of contracting officer.
• Money laundering.
• Improper sales and marketing practices (misleading or exaggerated advertising).
• False financial accounting.
• Environmental irresponsibility.
• Breach of privacy.
• Insider trading.
• Use of child labor.
• Tax evasion.
• Improper competition practices.
• Unfair labor practices.
• Counterfeit goods.
• Breach of copyright.
• Industrial espionage.

Facing and Resolving Dilemmas

At the core of many difficult decisions about personal or business issues, there is some sort of dilemma. A dilemma can be defined as a difficult choice with no simple easy solution. For example you might have received two job offers. The first one is exactly the kind of senior marketing position you were vying for and comes with a great salary but it is with a tobacco company and selling a product that slowly kills people is against your principles. The second offer is from a small company and the job scope is fine but the compensation package is very unattractive for you. You have been looking for a job for more than a year now and those are the only two offers available and due to financial constraints, you cannot afford to wait any longer. You are in situation requiring you to make a choice between equally undesirable or unfavorable options. Which one will you take?

A dilemma will put managers in an exposed position, as whatever the decision they take there will be an unacceptable downside, a negative consequence for somebody. Hence it is difficult to determine what course of action to pursue. Another example, imagine that you are negotiating a large, very lucrative deal for your organization. The problem is that you are aware of a potential downside that had not been properly evaluated using the current company assessment process. On the plus side, closing this deal will guarantee a fat bonus for your entire team. And you know that other teams within your organization have closed similar types of deals with similar risk profiles. Will you close one eye and secure that deal? It means leaving your organization exposed to significant liabilities if the deal goes wrong.

The basis of dilemma is often a contradiction between good and bad. Doing the right thing might lead to bad results and vice versa. Imagine for example that in order to buy a large amount of product from your company, a potential client requires receiving an “under table” commission. If you do not close this deal, you will miss your quarterly revenue target for the third time and most likely get fired. Will you seal that deal? Moral dilemmas arise when the division between what is ethically right and wrong gets blurred.

Dilemmas make managers very stressed as there are no easy ways out and there will often be severe short-term and/or long-term, tangible and intangible costs associated with any decision taken. Dilemmas cause what psychologists call a cognitive dissonance. This is what happens when there is a conflict between values and when somebody acts in a way that is inconsistent with his or her prior belief. This dissonance is a very disturbing and unpleasant experience, usually leading to strong negative emotions such as fear, anger and frustration. The individual experiencing the dissonance will feel the intense need to restore harmony by reducing the dissonance. Managers engaging in unethical and even fraudulent behavior when facing dilemmas will usually be subjected to a strong cognitive dissonance. The factors that help explain why managers will engage in unethical and even fraudulent behavior and how they may be able to reduce the cognitive dissonance and resolve the dilemma can be categorized as follows:

• Ethical Relativism.
• Pressures / Incentives.
• Opportunities / Risks.

Ethical Relativism

People do have principles they believe in but when they practice them, they will also have many exceptions to those principles. For example people may believe in honesty and the importance of always telling the truth. Yet in many cases the same people will not hesitate to lie and by doing so, go against the very principles they profess to follow. We could say that people are morally flexible. It means that practically what is good or bad depends on the context and consequences. To decide, it is necessary to analyze and carefully weigh the options when facing a dilemma. The goal is primarily to avoid negative consequences (especially the one that may affect personally the individual making the decision) by developing creative options.

Hence from that perspective, everything is relative and it is more and more commonly accepted that there are different ways to define truth and exhibit moral behavior. The rationale is that different people may hold different views and follow different principles or interpret those principles differently because of different cultural backgrounds, experiences or personalities. Who is right, who is wrong when everything is relative?

With that in mind it will not be too difficult for managers to rationalize their behavior and reduce the cognitive dissonance even if it violates important values and principles using the following types of arguments:

• “I have been unfairly treated.” The employee has been passed over for a promotion, given a very small bonus despite great results or has just been bullied by the boss. This might lead the employee to feel that taking home company assets is his or her right that he is just restoring the balance of what should have been done.
• “Everybody else is doing it.” Illusion of morality can set in when everybody in the same group is engaging in the unethical or fraudulent behavior. For example, using the corporate credit card for non-business related expenses. The fact that everybody is doing it may give each employee an incorrect sense that it is fine after all.
• “It is not me, it is my Boss.” In some cases, employees will engage in unethical or fraudulent behaviors because their boss told them to do it and they felt they cannot disobey their boss even if the order is unethical, or worse, fraudulent. It is a case of submission to authority, and the employee will rationalize himself as just a tool without free will and responsibility.
• “I'm not stealing, I'm just borrowing the money.” The employee sometimes does have the best of intentions to return the stolen funds. However, there's a snowball effect. The longer the employee gets away with the fraud, the more casual he becomes about the situation. The fraud usually escalates to the point where the employee is unable to pay back the stolen money.
• “I have no choice.” The employee believes he'll lose everything dear to him, including his job, home and family, unless he steals the money or commits the unethical act.
• “I will use it for doing good.” This “the end justifies the means” kind of justification is where the employee can rationalize his or her unethical and even fraudulent behavior because the end result is supposed to be good.
• “If I don't do it, somebody else will.” The inevitability justification: The idea that you cannot go against the flow because then you are missing opportunities or worse you could even get drowned. In 2007, Chuck Prince, former CEO of Citibank Group, to justify his blind pursuit of short-term profit during the subprime bubble, infamously said, “As long as the music is playing, we have to keep on dancing!” (Business Times, 2007).

Pressures / Incentives

It is about the pressure or “need” felt by the individual, which will lead him to commit the fraud. It might be real financial problems coming from personal problems such as unhealthy personal money-sucking addictions/vices (gambling, drugs, alcohol, mistress), or family needs (sick spouse, children), combined with insufficient capital, high debt level and credit difficulties. In most cases, the individual does not want his spouse, child, or parent to know about the problem. He will resort to self-help rather than risk being shamed by admitting that his debt is out of control. It could also come from work-related factors such as being overworked, underpaid and not promoted. There could be the case of too high a level of management pressure to achieve financial results coupled with inappropriate compensation systems that encourage excessive risk taking or a need to cover up someone's poor performance and hide losses. Finally, it could simply be pure greed, such as when a person has a strong desire for material gratifications and will stop at nothing to get what he or she wants. This includes the selfish pursuit of short-term financial gains generated at the expense of other key stakeholders, as Mr. Smith, a former vice president at Goldman Sachs puts it, referring to what he called the toxic culture of his organization in his resignation opinion published in the New York Times (2012, March 14), when he declared that “Not one single minute is spent asking questions about how we can help clients, it's purely about how we can make the most possible money off of them.”

Opportunities / Risks

Regardless of the strength of the pressure or incentive that an individual has, unethical acts can take place only if the opportunity is present. The opportunity for unethical acts or frauds can result from:

• Weak internal controls: Strong internal controls are a business's first line of defense.
• No separation of duties: This occurs when one employee handles many different related tasks. For example, the same employee opens the mail, logs in payments, and prepares and takes the deposit to the bank.
• Indifferent management: Sometimes management doesn't enforce the internal controls set in place.
• Ineffective monitoring of management: This takes place when the company is small and has few managers.
• Collusion among employees can circumvent even the strongest of internal controls.

As a French proverb states, “The opportunity makes the thief” – as soon as there are opportunities you will find people who will take advantage of them. The limitation is that the violator must feel that he/she can take advantage of the situation without getting caught and punished for it.

In conclusion, we need to be aware that when making decisions, pressures and rationalization from conflicts of interests and psychological biases are often underestimated, and will compromise our professional and moral judgment.

Establishing a System and a Culture of Risk Awareness and Ethics

For organizations to manage ethical risk issues effectively it is necessary to stop thinking like mechanics (hard controls) and to start acting like gardeners (soft controls). More and more, management control models emphasize the importance of soft controls and require the development of a pervasive ethical culture to support the control systems and processes in place. It is further recognized that effective compliance is an outcome of ethical behavior. Hence managing ethics and compliance risk holistically is key to fostering and sustaining a strong ethical corporate culture, to support ethical behavior in an organization. As the old adage says, “An organization is only as good as its people.” This is especially true in ethics and legal compliance, where successful management depends as much on how leadership and culture influences employee behavior as on the strength of controls and processes in place. From an understanding of the key factors that explain how unethical behavior can happen in organizations, we can define the key objectives of an effective ethical risk management system as follows:

1. Reduce and monitor pressures/incentives factors on employees to engage in unethical acts or even commit fraud.
2. Reduce an employee's ability to do the wrong thing and remain undetected for long periods.
3. Promote a strong risk aware ethical culture to make rationalization difficult.

Reduce and Monitor Pressures / Incentives Level

It is possible to reduce the pressures created by the stress of work by setting challenging yet realistic performance targets, ensure that pay systems can be perceived as fair by the employees and linking performance reward to real KPIs, i.e. drivers of value not financial results indicators. It also necessary to monitor “red flags” that may indicate that an employee is subjected to personal problems creating financial strain.

Reduce Opportunities, Increase Risks

It is essential to design and implement a solid system of internal management controls combined with effective management oversight of what is going on at every level in the organization. Checks and monitoring employees must be an ongoing process. Finally it is also important to keep people moving through job rotation and promotion so that they cannot build their own “black box” in their department.

Deal with Ethical Relativism and Make Rationalization Difficult

It is important never to underestimate the ability of the human mind to rationalize anything. Thanks to ethical relativism, with little efforts, people can actually rationalize a crime as being a benefit to society. Then the question is how to prevent inappropriate rationalization. The answer can be found in the nurturing of a strong ethical culture supported by adequate control systems. To reiterate, a corporate culture to support good and effective ethical risk management practices must have integrated at least the following values/principles:

• Think in terms of shared value and sustainability.
• Act with integrity and discipline.
• Be responsible and accountable for what they do.
• Be open and transparent about how they do things.
• Share information and knowledge proactively.

If it has not, unethical behaviors are inevitable and will ultimately lead to corporate failures. To create that kind of positive and ethical workplace environment and culture, it would be helpful the follow the steps highlighted in Figure 4.2.

First, the organization should develop a written code of ethics. The purpose of the code is to deter wrongdoing and to promote honest and ethical conduct that supports the business model of the organization and ensures compliance with applicable governmental laws, rules and regulations. The code of ethics should highlight the key principles and values that are supposed to guide decision making and describe what would constitute unethical or fraudulent behavior. It should also include a process for internal or external reporting of violations of the code to an appropriate person or persons identified in the code. Finally, it should define the accountability for adherence to the code and the sanctions to be imposed on those who breach it.

Second, it is also essential that the board and the senior management team take the lead in establishing the “tone at the top” by “walking the talk” as employees will naturally tend to follow the behavior of their leaders. Hence it is critical for the leaders to lead by example in setting professional standards and corporate values that promote integrity for themselves and other employees throughout the organization.

Third, shaping of employees' behavior can be achieved through the leading example of the senior management team supported by appropriate communication and regular training about the code of conduct and other important ethical issues. It is essential to link performance reward and promotion to ethical behavior so that employees are encouraged to do the right thing for their organization. Similarly organizations must ensure that they are hiring the appropriate employees who display a value system congruent with that of the organization. Finally, there should be zero tolerance for unethical behavior and any violation should be very firmly dealt with whatever the level of the employee concerned. The effort should be maintained over time to, fourth, ensure that the necessary principles and values become embedded in the culture and systems of the organization.

In conclusion:

1. Ethics is fundamental to enterprise risk management, and hence ethical culture objectives should be central to an effective ERM program.
2. Leading standards and regulations have recognized the centrality of ethics and have explicitly integrated ethics into the elements of effective enterprise risk management.
3. Organizations that are serious about implementing ethical principles and practices will not only protect their organization against damaging crises but also create tremendous benefits. A demonstrated corporate culture that supports and provides appropriate norms and incentives for professional and responsible behavior is an essential foundation of good governance, sustainable growth and profitability.