Sunday, December 21, 2008

Ethics in Management

According to Newsweek (December 22, 2008), consequent to the Wall Street crisis and economic meltdown, the United States would have to eventually spend US$ 8 trillion, in bailout funds and loan commitments. These funds are badly required to shore up the collapsed and collapsing banks, companies and intermediaries and avert an economic crisis of horrendous proportions. This bailout figure represents more than half of US GDP and is a truly astounding reflection of the bloated asset valuations and disguised financials that camouflaged some of the worst kind of corporate and accounting recklessness that was ever witnessed in the US. The issues in Europe and Japan and the consequent bailout commitments are estimated to be no less severe as per the magazine.

These recent happenings, particularly in the Wall Street and Corporate America brought the global economy into a tailspin and caused an unprecedented global liquidity squeeze. The underlying mis-management of economies, industries and corporations that has triggered the deep global recession brings to the fore the issue of ethics in management.

Several principal issues emerge. Are ethics a set of floating principles to be evaluated in a contemporaneous manner relative to the times? Do government regulations and rules as well as professional codes effectively promote ethics? Are individual and professional ethics oftentimes subordinate to corporate wealth maximization goals? What are the boundaries of action for the governments in the face of collective corporate mismanagement? What is the accountability and punishment for managerial recklessness and professional duplicity as well as complicity? How can corporate managements restore a measure of credibility for themselves?

Ethics cannot change; should be cast in stone

Ethics are defined as the moral principles that govern a person’s behavior or how an activity is conducted. Morality is the set of principles concerning the difference between right and wrong. From times immemorial what helps or uplifts the common man has been considered right while what exploits or hurts the common man considered wrong. Governments, which are the ultimate national organizations for managing the economies and the gross national products, are ordained to operate for society’s common good. Corporations which are the organizational instruments for wealth generation in different sectors through specific products and services cannot be any different.

Whatever are the times and whichever the nations, societies are stratified in terms of rich and poor, or high income, middle income and low income. Over time, however, governments have begun to place excessive emphasis on gross economic indicators such as consumer spend, housing stock and mortgages as reflective of society’s economic wellbeing. Individuals have also fallen prey to a single minded pursuit of wealth and/or credit-driven easy living where assets disproportionate to incomes are acquired adventurously. The underlying absolute and relative inequities suffered by the poorer sections have come to be overwhelmed by quantitative indices of gross economic growth, personal incomes and consumer spend.

Sadly, governments and companies began to ignore the ethical compulsions of directing
economic and commercial activities in such a manner that the poor are enabled reasonable and secure disposable incomes and are provided a quality of life consistent with changing times. Banks began enticing consumers with unreal and inflated asset values and indefensible mortgages, throwing safety to winds. Industries churned out inefficient but expensive products and services which came to be accepted by an elitist society with access to growing salaries and easy credit. Multi-million dollar bonuses and commissions computed on virtual and false profits, and golden parachutes of separation pay for senior executives became the rewards of a high-performance corporate imagery. Such lifestyle approaches and economic and business activities which bartered the hard savings of small investors and the job security of rank and file workers for the performance aggrandizement, in some cases, of CEOs, COOs and CFOs as well as other key managerial personnel can hardly be considered ethical. The need for the societies, governments and corporations to cast ethics in stone is more acutely felt than ever.

Regulations have to move beyond compliance reports

Post-Enron, the US has prided itself to be the torchbearer of corporate governance, statutory compliance and risk management. For example, the Sarbanes-Oxley Act enforced on July 30, 2002 in the wake of several corporate and accounting standards imposed a host of governance, compliance and reporting restrictions on corporations listed in the US. What happened in 2008 in the Wall Street and Corporate America is a true shocker on how intrepid and avaricious managements can cleverly circumvent the toughest of regulations.

The US has a legion of legal and governmental boards, commissions and committees, executive departments, independent agencies, judicial organs, legislative bodies and quasi-official watchdogs which are entrusted with oversight on corporate, professional and accounting behavior. Securities and Exchanges Commission, NYSE and Nasdaq have stringent listing and reporting requirements. If the sophisticated governmental agencies fail to detect the economic rumblings and the SEC and stock exchange regulations fail to check incorrect and incongruent business and accounting practices, it is not ethical governance and management either.

The striking takeaway is that regulation has to be internally inspired and intrinsically self-driven. Each company or management knows fully well what it does. The board or the audit firm, despite diligence, has to essentially rely on certifications by the management. It is the ethical perception of the management that differentiates a well-regulated and truly compliant firm from a wayward and exploitative company. No amount of external regulation or board supervision can avert an unethical management from undertaking activities that destroy value for the common man. If only the ethics of larger good for the poorer sections of society are given the governing position such distortions would not occur. It is time that all educational curricula, be they science, engineering or management, incorporate ethics prominently in the studies, and all professional bodies, be they of accountants, analysts or company secretaries, insist on ethics based operations and performance reporting.

Personal and professional ethics should override corporate wealth goals

The CEO who drives growth by stretching resources beyond a sustainable balance or by expanding business boundaries ignoring core competencies has learnt to subordinate his professional logic to personal aspiration. The finance manager who seeks funds based on erroneous use of funds does so thinking that it would help the company raise cash to compensate for performance shortfalls. The procurement manager who sources products from emerging economies at irrationally low prices believes that it helps his company earn enhanced margins. The sales manager who stuffs trade channels with his products thinks that he is preempting the shelf space for his competition. The operations manager who settles for low productivity is happy not to upset the harmonious industrial relations in the company. Each of the above officers in the process is failing to realize the harm he or she is doing to the company in terms of long term risk profile, financial instability, quality erosion and bad debts.

Each of the corporate officers illustratively mentioned above has the academic education, professional experience and hopefully personal value system that would tell him or her at first pass to do the right things. However, the superimposition of a corporate role wherein he or she has to contribute to higher revenues or profits or lower costs as his or her key performance metric makes the officer to work for corporate profit maximization as a short run goal. No wonder that a series of corporate profit driven thought processes and actions across the entire hierarchy institutionalizes an organizational eco system which would reward contribution to short term profits and discourage, if not penalize, value building for the future.

While there is no denying that business organizations cannot be run as charitable bodies and they do need to generate wealth to be able to distribute to its stakeholders, clearly considerations such as quality, safety, health, environment, risk and social responsibility have to be given equal weight. The model of “leadership through trusteeship” set by the TATA group in India acting as trustees for public wealth through their corporations is a model worth emulating. Corporate managements and boards have to establish ethics forums where such issues can be brought up and debated. Progressive companies could support this trend by establishing a departmental structure for managing ethics oriented issues. Sooner than later, it should be mandatory for each company to have a Chief Ethics Officer with a board representation and whose compensation and employment contract are guaranteed by a department of ethics in the federal government.

Governmental power and accountability on ethics to be significant

Governments are expected to be the ultimate custodians and trustees for public good. However, as one watches the activities and intents of the governments the world over, whether of dictatorial or democratic variety, one would be saddened that there are only very few enlightened governments and even fewer welfare states. Governments which are regressive in outlook, which indulge in wars and terrorist actions, and which encourage crony capitalism or state corruption can hardly be the role models of ethics.

Governments have to be modern, secular, equitable and ethical to do good for all sections of the society. It appears that the well established ‘checks and balances’ system of government (or the executive), legislature and judiciary has to be further strengthened by creating a constitutionally ordained body for protecting and promoting ethics. Watchdog bodies, vigilance commissions and audit bodies may be brought under the control of such a ministry of ethics.

The events in Corporate America have proved beyond doubt that ethics cannot be implemented through regulations as they are often reduced to meaningless numbers and verbose texts of corporate reports and compliance documentation. Governments have to assume the primary responsibility for ethics by setting example in conduct of governmental affairs, be it in terms of aiding other ethical and democratic nations or curbing elitist and exploitative practices within the country. While the US government may have been corporate-friendly in terms of bailing out many errant corporations by doling out billions of dollars, it is sad that the government is also appearing to be hapless or powerless in the face of collective mismanagement by that many corporations. A more socialistic regime would have totally nationalized such failing enterprises as a quid pro quo for the exceptional funding support provided. While largely adopting an ambassadorial role for ethics, governments should also not fight shy of punishing malpractice wherever it occurs and thus emerging as a powerful icon of ethical accountability.

Corporate recklessness and professional duplicity need deterrence

In the normal course, corporate hierarchy and managerial processes together with the board supervision and investor activism ought to be providing the requisite deterrence against corporate recklessness and professional duplicity. Unfortunately, this does not seem to be adequate or even appropriate to stem unethical practices. The earlier analysis

illustrated that in an era of falling ethical values, a variety of inducements and aspirations, including corporate wealth maximization and personal aggrandizement lead to failures in corporate governance. Unquestioned leadership adulation adds an aura of invincibility for the top leaders when corporate performance is seemingly on a high.

There is considerable body of knowledge that suggests that ethics and values are the superior ethos that control, minimize and refine the primal instincts of human race. As ethics and values fall, greed is the lever that triggers malpractice and fear is the counter-lever that can deter and correct it. Today’s environment suggests that corporations and their CEOs and CFOs are unlikely to have learnt their lessons as they have had fairly easy bailouts and the leaders personally had easy separations, in most cases with multi-million dollar separation payments.

There is a need to engage the failed leaders not necessarily to punish them legally for their erroneous judgments or acts, but to bring out the deficiencies as a warning to others from following similar dicey pathways. It is also necessary to ensure some justice by not allowing such failed leaders to apparently go into oblivion and actually rehabilitate themselves. Bad management and faulty leadership need to be chronicled as much as good management and robust leadership to ensure corporate and professional integrity. Perhaps it would not be inappropriate to establish a journal for failed leadership and management practices and doomed business models. It may even be worthwhile to establish an academy for failed but contrite leaders and a hall of infamy for failed but unrepentant leaders.

Leaders and managers can, and should, work to restore their credibility

Nations and governments do not have unending fountains of dollar-billions to save failing institutions and trigger exceptional stimulus packages and thus insulate economies from deep recession. What has been done for certain financial institutions and automobile companies in the US cannot be repeated for the whole spectrum of enterprises which may start seeking such aid. Banks cannot keep lowering interest rates or keep reducing reserve ratios to enhance velocity of money in the system. It is the corporate sector that needs to act sensibly and soundly to restore its credibility and consequently restore public confidence in the economy.

Leaders and managers have to connect themselves with the changed realities and modify their business plans on the basis of better products, higher productivity and improved pricing that in combination would provide greater value for the customer. Leaders and managers will need to work with scientists and technologists to design new products and adopt better manufacturing practices. As the CEO of Fiat has illustrated in his turnaround story, all CEOs should cease dominating their companies through individual hegemony and instead focus on developing multiple leaders who can drive recovery and rejuvenation.

Corporations have to look beyond the tyranny of quarterly guidance and build value for all stakeholders. Organizations have to refocus on core competencies but go beyond them to develop game changing paradigms that create new markets through innovative products. Japan has always been adept in the innovation game; Korea has been a successful player of late. India has scored an inflection point with the design and manufacture of a transformational micro car called Nano. Leaders and managers have to disown their egos that are fed on external adulation and internal submissiveness over the years, re-learn time-tested ethics and values, and facilitate the spread of ethical leadership and management in their companies. Competence with humility and a concern for equity would lead to a restoration of credibility for the leadership and management in the corporate sector. Leadership and managerial credibility based on sound ethical values would be essential to restore public confidence in the consumer markets, stock markets, housing markets and the economy in general.

The global economy and the comity of nations are facing an economic crisis of unprecedented scale, scope and depth caused by corporate recklessness and in some cases leadership malpractices. Erosion of ethical principles in public governance and corporate management as well as in individual and professional life aspirations are at the root of this sordid saga. When ethics are restored in all walks of life in their pristine purity, there would be sustainable growth with equity all round.

Posted by Dr CB Rao on December 21, 2008

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