At the beginning of the year, corporate skullduggery seemed limited to one or two egregious examples. A couple of bad apples won't spoil the whole bunch, we said to ourselves. But in the past several months, rottenness may have achieved a critical mass. After such a pervasive breach of trust, can corporate America ever win back people's confidence? Harvard Management Update recently discussed this issue with Thomas R. Piper, Lawrence E. Fouraker Professor of Business Administration at Harvard Business School and coauthor of Can Ethics Be Taught? (Harvard Business School Press, 1993).
Q: Why is all this misconduct occurring now?
A: I think it's the confluence of several factors: the use of powerful incentive packages, an exuberance that pushed equity prices to heights that were hard to justify economically and yet were very important to the wealth position of senior management, and insufficient institutional checks and balances. At Enron at the end of 1999, the options that were vested were worth $2.4 billion. That is too much temptation to put in front of people—temptation to sell out secretly, "cooking the books" as necessary to hold up the share price in the meantime.
Were equity markets highly efficient, these actions would be recognized; an immediate decline in share price would occur; and, anticipating this, managers would not be tempted toward misconduct or "short termism." Unfortunately, the markets are limited to publicly available information. They do not punish with sufficient speed and force to eliminate the incentive for misconduct.
At a time when the temptation before some managers is orders of magnitude greater than twenty or thirty years ago, the concern is that the external checks and balances have weakened under the influence of conflicts of interest. For example, the change in the commission structure in 1974 created a whole new dynamic that influenced the role of research by investment banks. And the growing importance of consulting at public accounting firms may well have shifted power from the accounting principles committee to relationship managers.
Q: Did the rules change? Or has the policing not been strong enough?
A: Maximizing shareholder wealth has become the overarching corporate goal, and whatever it takes to accomplish that seems to be deemed OK. Ethics—that is, notions about honesty, transparency, and a concern for a wide range of constituencies—has been pushed aside and has been replaced by a technical definition of what is acceptable. So there's also no question that we need to strengthen the internal systems that guide conduct within a firm: performance evaluation systems, reward and punishment systems, compliance systems.
[Markets] do not punish with sufficient speed and force to eliminate the incentive for misconduct.
Q: So the problem was making the maximization of shareholder wealth the primary goal?
A: The idea of emphasizing shareholder wealth wasn't a bad message. It was shorthand for, "Let's focus on becoming much more efficient in competitive terms." And it worked in accomplishing that objective. But it fails to connect to all the constituencies—other than the shareholders—whose energies and commitment you need. They heard it as, "Let's make rich people richer." And it didn't address the matter of how the maximization was to be accomplished.
You can't take your eye off profitability. But to make all the other stakeholders instruments of shareholder wealth maximization won't win you their trust. And in the long run, the well being of organizations and of society depends on trust.
So the zone of sustainable action for a business should be the overlap between ethics and economics. The role of the organization is to ensure that all activity occurs within that overlap; the role of leadership is to expand the overlap.
Q: What's your assessment of the recommendations being made to restore trust?
A: I think a lot of the recommendations will turn out to be helpful—whether it's trying to either ensure rotation of engagement partners (which we've had for quite some time now) or, alternatively, full rotation of firms doing the audit. We'll begin to look at the design of option plans and be much more careful about the rate at which they vest. There'll be talk about whether some of the proceeds should go into incentive banks, with a claw-back if there's poor performance. We'll talk about whether directors on audit committees should be heavily involved with options. No one change by itself will be enough.
CEOs must address the organizational architecture: the planning systems; the performance measurement and evaluation systems; the incentives systems; the boundary systems that say, "You've got freedom within these limits, but you are not to go outside them in terms of conduct or operations or strategy"; and also the belief systems, which don't simply set forth a list of Thou shalt nots, but which address what the organization positively stands for in terms of mission, purpose, and principle.
A company's financial systems are so powerful in communicating what that company stands for—they're not just neutral mechanisms.
—Thomas R. Piper
In the good times, it seemed as if most of the emphasis was on diagnostic performance measures—which were often incomplete and were primarily financial—and big reward systems. We didn't pay as much attention to boundary systems. And it sure felt as if we didn't do very much around belief systems.
What I don't know, however, is whether we're going to move beyond the concern about misconduct and discuss other dimensions of corporate responsibility.
Q: While we're on the subject of responsibility, do you buy it when a CEO says, "I didn't know," about questionable practices?
A: I think the strategy of deniability is a very dangerous one to allow to stand. A CEO should understand what's going on in the organization. A company's financial systems are so powerful in communicating what that company stands for—they're not just neutral mechanisms. They tie into compensation and performance evaluation systems, so for a CEO to say, "I didn't know," I think is quite unacceptable. I think either the person intentionally didn't know or, alternatively, wasn't doing the job.
Q: What role do senior managers have in improving the situation?
A: Senior management has the responsibility to send a strong message that how one accomplishes the objectives is important, and that honesty, transparency, and a concern for the various constituencies are not to be compromised. It then must ensure that the various internal systems are consistent with the conduct desired—and then it must walk the talk. In a world filled with cynicism, people spot the contradictions very quickly. Finally, senior management needs to encourage the discussability of questionable practices by individuals throughout the organization. Discussability is a critical first step in moving toward better practice.
Q: You seem to be saying that ethics can't be taught—at least not in one day or even one semester.
A: There is no quick fix. Special all-day meetings or corporate-wide mailings, if inconsistent with the realities as revealed by daily operations and actions, risk being seen as little more than a public relations move.
Ethical foundations are laid down early in one's life, but I do not accept the notion that we are fully and immutably formed by the age of four or five, or even at the age of 64. However, whatever our personal ethics, we are still confronted with these questions: "What does this organization stand for in the way of ethics and corporate responsibility? Can I bring my personal ethics safely through the company gate?" These lessons are taught daily within the organization through the actions and the silence of leadership. Not only can ethics be taught, it is being taught every time people watch what you do and what you don't do.
The issue is not whether ethics can be taught, it's whether the ethics we're teaching through our actions reflect the ethics that we intend to teach.