Ethics & Employees

Speech by Frank Vogl

Address to Valmont Industries Accounting & Finance Seminar, Omaha, Nebraska, May 15, 2005

Introduction

Corporate scandals have diminished public confidence in the leadership of American business. More investigations and scandals are probable and they may lead to still more public anger and more pressure on politicians and regulators to respond. The first round of scandals saw Congress pass the Sarbanes-Oxley Act. Since then we have learned about fraud and malfeasance in the mutual fund and insurance sectors and in a host of major corporations.

There is a grave danger that the politicians will continue to believe that they can legislate ethics. The danger is to our economic system. More official regulation will threaten the vibrancy of enterprise, undermine our free market’s creativity and flexibility and damage our economic prospects. It is urgent that business demonstrates that it recognizes these dangers, that it understands the need to restore public trust through its own voluntary actions.

Why has this crisis been so large and embraced so many corporations? There are many explanations, but an important one relates to technology. Embarrassing e-mails at Boeing, Enron, Merrill Lynch, Credit Swiss, Morgan Stanley and scores of other enterprises have shown how greed triumphed over sound ethics. The hard-drives of corporate computers are revealing secrets that are exposing myriad unethical practices. In this era of an aggressive Securities and Exchange Commission, Elliot Spitzer, the Internet and a media fascinated by business scandals, the corporations of America have nowhere to hide.

Thanks to the Internet the ability of corporations to keep information confidential is declining fast. Meanwhile, the scale of false information about corporations that appears on the web is multiplying. As we look ahead we must come to terms with four considerations:

• The amount of information available in the public domain about every aspect of a publicly quoted corporation’s business will rise.

• The number of investigations into corporate wrong-doing will increase.

• The sophistication of pressure groups seeking to force corporations to reform will grow.

• And, these forces will compel business to recognize that when there is nowhere to hide, then there is no choice other than to confront the wrongdoing in its midst and institute reforms consistent with this age of transparency.

Public Pressure

It is important to recognize that the public at large drives the zeal of the official regulators and the reform-minded politicians. Public anger should not be underestimated. Through pension and other funds there are more than 80 million Americans who are owners of parts of corporate America – and vast numbers of these shareowners have lost money because of the malfeasance of a few executives in a range of leading companies. Millions of American investors have been cheated.

The top executives at numerous companies, from Adelphia to WorldCom, have been seen to engage in unacceptable behavior. Martha Stewart went to prison; Ken Lay awaits trial; Bernie Ebbers awaits sentencing. Despite all the publicity, many business leaders still don’t get it. Numerous top executives are taking home vast compensation awards, while their company’s stock declines. Avarice and arrogance combine – even now – to lead companies into trouble and to endanger their reputations – and a corporation’s reputation is its most valuable asset.

The Values Equation

I believe there is a Values Equation that can be defined as: investing to build trust in corporate leadership, all other factors being equal, yields competitive advantage. Arguing for greater corporate attention to ethics is sound business advice. Excellent ethics management is key to sustained corporate profitability and health.

Understanding this has made Johnson & Johnson a great firm. This company lives by its “Credo.” It publishes it each year in its annual report. It ensures that all employees worldwide understand it, respect it and act in its spirit. It does not place the maximization of profit or securing shareholder value at the top of its Credo. It starts by declaring, “We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services.”

Or take global oil giant BP, which publishes an annual report on its corporate social responsibility that is candid and thus credible and that secured the following headline recently in The Financial Times: “BP sacked 252 for unethical behaviour.”

We must understand the Values Equation and put it into practice. Building trust and acting with integrity is not a defensive posture, rather it is something very positive. Acting with integrity is critical to building lasting, strong, efficient companies.

Ray Gilmartin, who recently announced that he is stepping down as the Chairman and Chief Executive Officer of Merck & Company, once wrote that, “People are beginning to realize that ethics and integrity are actually sources of competitive advantage because they inspire trust, not only for the employees but also for customers. Organizations that enjoy a reputation for business ethics and corporate responsibility understand that business ethics are dynamic; they must be a continuing priority.”

I admire Mr. Gilmartin as a committed ethical leader. I believe that Merck’s problems today over Vioxx are the result of a company striving to do the right thing, even at huge financial cost and indeed at risk in the short- to medium-term to its reputation. But, that is the acid test of ethical leadership and I believe history will place Merck’s leader on the right side.

Jack Welch, when he headed GE, was insistent on the relationship between employee values and business success, as is his successor, Jeffrey Immelt. Commenting on a set of excellent GE corporate results in 2002, Welch declared in the company’s annual report: “V alues and behaviors are what produce those performance numbers, and they are the bedrock upon which we will build our future.”

Welch argued that competitive corporations can no longer employ multitudes of managers whose job it is to supervise other managers and teams of employees – bureaucracies have to be fought and chains of command have to be flattened. Competitive demands lead to a constant effort to boost the individual productivity of each employee and this is only possible with reduced supervision and greater trust. Such a system, however, can only work when all employees accept and support a common set of corporate values that places integrity at the center. It is what General Motors labels, “Winning with Integrity.”

Doing the right thing in business means being honest, not cheating, not lying, and not pursuing actions that demand secrecy. Doing the right thing demands a sense of fairness and equity. It demands that supervisors demonstrate respect for all employees and for each other. It requires that top executives demonstrate integrity through personal example on a consistent basis. Sometimes it requires companies to make exceedingly difficult choices between losing business while holding true to their ethical cultures and codes of conduct, or making that additional profitable deal by setting the ethics code aside.

The Value Equation applies as companies seek to recruit and retain the best and brightest employees. Goldman Sachs noted in its 2000 Annual Report: “Our distinctive culture, which emphasises integrity, entrepreneurship, excellence, teamwork and fairness, has allowed us to assemble the most talented team in the business.” And, “This activity (strengthened overall business operations) is all predicated on our continued ability to attract and retain some of the most talented people in the world. Our culture is the glue that makes this possible.”

A 10 Point Ethics Framework

Every company faces the danger of rogue executives. The best means of guarding against the rogues is the establishment of a strong corporate integrity culture, involving good monitoring and substantial employee training. There is no magic formula, or perfect code of conduct to inspire sound business ethical practice. But, let me suggest that to implement the Values Equation, a company, at a minimum, needs to adhere in its day-to-day business activities to a 10-point ethics framework:

• Law. Operate in accord with the spirit, not just the letter, of the law.

• Ethics Code. Place the corporate code of ethics at the center of corporate operations and decision taking and never, under any circumstances, set aside the code to permit special actions by executives (the Enron Board, for example, twice waived the corporate code with a formal vote).

• Honesty . Demand that all corporate employees, starting with the CEO, are truthful with their colleagues, their customers and when representing the enterprise to the public.

• Information Sharing. Encourage managers to maximize the sharing of information with their subordinates and encourage transparency at all levels within the corporation.

• Equity & Employee Respect . Pursue policies of zero tolerance regarding all forms of sexual harassment in the workplace and discrimination on the basic of race, color, gender and age.

• Whistleblowers . Management and the Board of Directors should ensure that whistleblowers are protected and indeed encouraged. When an employee sees wrongdoing, then she or he should be encouraged to report the malfeasance – at stake is the reputation of the company.

For example, on Morgan Stanley, See Page 1, Wall Street Journal, May 16, 2005

Financial Times Tuesday April 12, 2005. Page 27.

Signed article by Mr. Giulmartin in The Detroit News, June 11, 2003.

• Ethics Reporting. Require that senior corporate executives, including a chief ethics officer, report regularly and fully on the operational effectiveness of the corporate ethics code to the Board.

• Accountability. Demonstrate to shareholders that members of the Board of Directors operate with the clear understanding that they are fully accountable. Boards should be seen to be bending over backwards to ensure honesty in corporate reporting and responding to shareholder requests for information and explanation.

• Compensation. Formulate approaches to executive compensation that recognize that this is a matter that contains within it key issues of ethics and, in this regard, ensure high levels of transparency in the deliberations of board compensation committees.

• Citizenship. Understand that American corporations, like decent citizens, must operate in ways that serve the core interests of the nation.

A Global Dimension

Permit me to just elaborate on this issue of citizenship. A company is a citizen of the countries in which it operates and as such it has societal responsibilities. It needs to demonstrate that it understands this. It needs to show respect for the natural environment and for the human rights of the people it works with. It dare not pay bribes to foreign officials.

Corporate scandals, starting with Enron’s collapse, have damaged the standing of our country in the world. Our competitive capitalist system appears tarnished. Nobody should be surprised that companies that cook the books at home, lie to shareholders and regulators and have top executives who pocket fortunes irrespective of corporate performance, may be viewed abroad with skepticism and suspicion. Such negative perceptions damage U.S. competitiveness in the global marketplace.

Enron, for example, not only imploded because of domestic fraud, but has also faced allegations of using bribes in its overseas business operations. In much of the world the issue of corruption tops the list of concerns when business ethics is discussed. Here, perceptions of U.S. corporate behavior leave much to be desired.

Surveys conducted by Gallup International for Transparency International have suggested that U.S. firms are perceived in numerous foreign countries to pay even more bribes to foreign governments than, for example, French, British, Canadian and Scandinavian companies. It is possible that this negative view is influenced by the propensity of U.S. firms to use a loophole in the Foreign Corrupt Practices Act. The FCPA says that “facilitating payments” may be made by U.S. corporations to foreign officials and what is meant by this are small payments to customs officials and other middle- and low-level foreign government officials who impose excessive red tape on U.S. business in order to extort small bribes.

The use of “facilitating payments” is symbolic of so much that is wrong with American business values today. The U.S. law approves actions by U.S. companies abroad that are illegal at home. Imagine the reaction here if German companies started paying small bribes to U.S. customs officials, or Japanese firms gave kick-backs to U.S. immigration officials! Defenders of “facilitating payments” are defending a double-standard: they are saying one set of values should apply here in the U.S., but another lower standard is alright overseas.

Across the world the “facilitating payments” are seen for what they are: bribes. American corporate lawyers can strive to justify them before the U.S. Justice Department and the SEC, but these payments are still bribes and they contribute to corroding the fabric of law, good governance and indeed democracy in scores of nations.

Using “facilitating payments” damages the image of American business. It leaves the U.S. well behind the curve in the global bid for anti-corruption, which has seen the U.K. adopt a tougher law than the U.S. and led companies like Shell and BP to make statements against facilitating payments. Their statements are models

The corruption issue is just one of many on the international corporate social responsibility agenda. Tens of thousands of American firms operate internationally. Their approaches overseas have to be just as ethical as at home.

Sarbanes-Oxley

And, here at home, few ethical issues have so concerned business leaders and regulators alike as those related to audit oversight. Sarbanes-Oxley opened a new era of auditing accountability. It saw the establishment of the Public Company Accounting Oversight Board (PCAOB), which has placed the actions of auditing companies explicitly under regulatory review. Then, Sarbanes-Oxley placed explicit responsibility for the corporate accounts and the accuracy of the balance sheet on the Chief Executive Officer and Chief Financial Officer with severe penalties for each in the event of non-compliance. The new law has strengthened regulatory rigor and raised the stakes for those who place greed above other considerations. As you well know, the new law also calls on companies to assess the independence and reliability of their internal audit controls.

Auditing is an art where judgment is crucial at all times. There are many specific kinds of situations where there is no perfect answer. If it was an exact science, then someone would have invented a computer program that could automatically do all the accounts and provide the accurate audit – but the skills of the auditor rest on keen insight and understanding.

While judgments are now subject to more review and debate, perhaps, than ever before, we should not forget that what happened at Enron and at numerous other companies had absolutely nothing to do with the finer points of interpreting accounting rules. The cases of Enron and Adelphia and WorldCom involved fraud. Audits were rigged to secure inappropriate gains. But should the frauds of a few lead to penalties for all honest auditors and the companies that employ them? Put another way: has Sarbanes-Oxley gone too far?

There are numerous business leaders who have been vocal in their complaints about the new requirements. Without entering into the precise merits of the arguments, let me go to the politics. The facts are that the public at large reads about AIG and malfeasance at major mutual funds, and the court cases now involving HealthSouth and Morgan Stanley and Adelphia and WorldCom and Tyco and Enron and it is, accordingly, in no mood to rollback Sarbanes-Oxley.

Moreover, as the public reads about huge pay for top CEOs, so its concern about ethical business leadership only rises. You can imagine the reaction among readers of The New York Times when they opened their newspaper on April 16, 2005 and read the headline: “ While Shares Fell, Viacom Paid Three $160 Million.” While Viacom’s Board of Directors no doubt felt it had good reasons to lavish huge remuneration upon its trio of top executives, the immediate impression among readers of the news was assuredly negative and damaging. And in today’s environment this adds to negative public perceptions of business.

Bribe Payers Index published by Transparency International, the Berlin-based anti-corruption organization with polling data by Gallup International.

More generally, c onfusion is understandable, for example, when people read that the average American worker saw pay rises of 2.9 percent in 2004 to just over $33,000, while total CEO compensation, according to a Business Week survey of 367 companies, rose by an average of 15 percent to $9.6 million.

William Donaldson, the Chairman of the SEC, stated before Congress recently that the application of the Sarbanes-Oxley act on internal auditing controls, “Should have an enormous positive impact” on public companies. He argued that the time and investment in compliance will yield handsome returns and that the costs will, in fact, decline over time. You may disagree. But, the fact is that sensing the broad public mood, the SEC is in no mood to bow to corporate pressures to reverse Sarbanes-Oxley.

Companies, whether they like the law or not, have no choice other than to plan for long-term compliance.

The American Workplace

To be sure, the scandals have produced a distorted picture of ethics in American business. A more balanced picture would take into account significant improvements that have taken place in the American workplace – well beyond the confines of the top management offices. We can take some comfort from the important results highlighted in the National Business Ethics Survey conducted by the Ethics Resource Center in 2003, which involved detailed interviews with 1,500 American workers across the nation. The survey found that most workers saw improvements in ethical behavior in their places of work compared to the results of a 2000 ERC survey. My hope is that the ERC’s next national survey, which will be published this summer, will show still further improvements.

The last ERC report revealed the first overall drop in observed misconduct seen in a decade: from 31% in 1994 and 2000 to 22% in 2003. Employee reporting of misconduct increased to 65% in 2003, continuing an upward trend from 2000 (57%) and 1994 (48%). In addition, perceptions that top management “keeps promises and commitments” went from 77% in 2000 to 82% in 2003.

The report showed that lying to employees, customers, vendors and the public is down to 19% from 26% in 2000. Similarly, withholding needed information has dropped to 18% from 25% and discrimination on the basis of race, color, gender and age is down to 13% from 17%.  The percentage of employees saying that they feel pressure to compromise the ethics standards of their organizations also declined from 13% in 2000 to 10% in 2003.

The ERC’s new national survey will be used as a core benchmark for many corporations as they conduct internal surveys of their employees in efforts to develop training programs and address workplace ethical issues. It is an invaluable tool produced by an outstanding organization. Sarbanes-Oxley and new Federal Sentencing Guidelines have heightened the focus on workplace ethics and rightly so.

Let me emphasize, that what really matters is the consistent high priority attention in companies to securing an ethical culture. Studies by the ERC have found that when a corporation has a strong ethical culture, where top managers, supervisors and coworkers, all display "ethics related actions" and really walk the talk, rather than just paying formal lip-service to an ethics code, then workplace misconduct can decline by more than 30%.

Staying Competitive

As noted at the outset, the critical challenge posed by the scandals and the continuing public concern relates to our economic system’s future. American-style capitalism is a freewheeling system based on strong public and political support for the view that business best serves the national interest when there is a minimum of governmental regulation and interference. We believe in free markets.

From Canada to Germany, from France to Japan by contrast, let alone in less developed economies, a finer and more sensitive balance is struck. Overseas public and political opinion leans more greatly than in the U.S. towards larger regulation of free enterprise by government.

At the center of the differences is the issue of trust. Fundamentally, the relatively low level of governmental restraint over business in the U.S. compared to other nations reflects American public trust in the system and the business enterprises at its center. Abroad, there is relatively less trust that business, when left to its own devices, will serve the national interest.

The differences between national approaches to capitalism rest in the fine balance between governmental controls and the freedom of business people to operate as they wish. The U.S. system is more trusting of business than foreign systems. Regulate too much and the wings of entrepreneurship will be clipped. Create too many new laws restricting the actions of business and corporations become more bureaucratic and less flexible. Develop all kinds of new rules to guard against business abuse and the result will be excessive caution and risk-averse business attitudes, which smash the forces of innovation.

Therefore, the outrage over the greed of business leaders could stimulate political and regulatory actions that straightjacket the American capitalist environment in just the same way as modern entrepreneurship is enmeshed in red tape in Europe and in Japan. The result is that our rate of economic growth would slow to match the sluggish levels seen in Europe and Japan and our innovative entrepreneurship would be undermined. That, I submit, is too high a price to pay.

Conclusion

Building trust and securing vibrant business ethical cultures calls for an intense combination of committed players.

• External Auditors need to shine as outstanding models of integrity. The reputations of the largest firms continue to be battered as new scandals in corporate America surface. In an official statement recently released by the SEC it was announced that KPMG agreed to pay $22 million to settle SEC charges against it in conjunction with the audits of Xerox Corporation from 1997 through 2000. Paul Berger, an SEC Associate Director of Enforcement stated, “Audit firms play a critical role in the financial reporting process. The investing public deserves to know that auditors will be held accountable when they fail to perform their duties with the degree of professional care required of the auditing procession.”

• Internal auditors have no less a responsibility. The frauds at numerous companies have shone a blistering light upon internal auditors. Sarbanes-Oxley is a response. But, there needs to be leadership here with all responsible for auditing within firms striving to serve as models for their colleagues – models of ethical judgment and integrity.

• We need corporations to ensure that their chief ethics officers have genuine influence, with direct access to the CEO and also to the Board of Directors. They need to have a seat at the table, just like the corporate lawyers, when key corporate transactions are discussed. They should not be reporting to the legal department, or human resources, but recognized as performing a vital and independent senior management role. They need to be excellently trained and visibly authoritative within their enterprises.

• Moreover, we need chief executive officers to demonstrate at all times – not just in the midst of a scandal or directly thereafter – that doing the right thing is not a choice, but a necessity. The best leaders in business are those who understand that there is a Values Equation whereby strong integrity influences long-term corporate strength.

• And, then there is the Board of Directors. It has the key responsibility for oversight of the management. Its actions can determine the corporate culture on a continuing and lasting basis. Its attention to excellence in auditing and to fairness and transparency in executive compensation can make a major difference.

The Board’s recognition that companies have nowhere to hide should serve as an incentive for effective ethical oversight. And, the Board’s ability to focus management on the 10-point ethics framework that I noted earlier is essential if companies are to secure their prime asset – their good name.

Rewards will go to those companies whose brand equates with trust in the eyes of employees, shareholders, customers and suppliers with trust. And strengthening trust is essential for our nation’s prosperity.

Thank you.