The ethical dilemma of corrupt practices and

good governance

Can corporates draw the fine line?-April 10, 2015

I am certain that most of youhave heard of the Enron scandal which led to
the bankruptcy of the Enron Corporation, an American energy company
based in Houston, and the dissolution, in 2002, of Arthur Andersen, one of
the five largest audit and accountancy partnerships in the world.
Enron, through the use of accounting loopholes and poor
financial reporting, hid billions of dollars in debt from failed
deals and projects. It became the first non-financial company
to use the mark-to-market accounting method to account for
its complex long-term contracts.
As you all know, mark-to-market accounting requires that
once a long-term contract is signed, income is estimated as
the present value of net future cash flow. Often, the viability
of such contracts and their related costs are difficult to
estimate and investors are given false or misleading reports.
Enron also used off-balance-sheet entities to artificially inflate
profits to make the Company look financially secure when it was not.

Enron fall
How and why did Enron which was voted as having one of the best Boards
and as one of the best companies to work for in America derail? Even with
complex corporate governance mechanisms and checks and balances in
place, Enron was able to attract large sums of capital to fund a
questionable business model, conceal its true performance through a series
of accounting and financing manoeuvres, and hype its stock to
unsustainable levels. It derailed because it lacked an ethical compass that
propelled corporate governance and business practices in the right
direction.
Former CFO of Enron Andy Fastow evidences this when stating that

Accounting rules, securities laws and regulations are vague. Theyre

complex What I did at Enron and what we tended to do as a company
was to view that complexity, that vaguenessnot as a problem, but as an
opportunity. The only question was do the rules allow it or do the rules
allow an interpretation that will allow it?
Fastow later testified that he knew it was wrongknew it was misleading
but neither he nor his senior colleagues acted on the truth, leading to
corrupt governance of the highest order.They failed to draw the line! But
what is this line?
Almost all of Enrons projects and deals were approved by auditors, lawyers
and even by government bodies. Were they really doing something illegal?
The simple answer is NO. Companies, after all, like human beings do not
exercise consistent moral behaviour. But with growing transparency and
accountability in a globalised economy, corporate organisations not only
need to acquire a sound business sense in the competitive marketplace but
a constant reflection of are we doing the RIGHT thing? To an ethical
business organisation, ethics is not merely about adherence and
compliance to a set of regulations. Nor is it about trying to bend the rules
without breaking them. It is about doing business RIGHT. This is where
Enron failed miserably.
Businessand ethics
Often business and ethics are viewed as two separate worlds. Yet a
sustainable business is defined by the ability of companies to do repeat
transactions with their customers. Customers need to feel that they are
treated fairly and honestly. In places where institutions are weak, ethics
plays a fundamental role in facilitating repeat business transactions and, as
such, driving a sustainable private sector. Ethics is no longer languishing in
the periphery of the corporate structure. Instead, it often acts as the
conscience of the legal person or corporate, providing it a moral core.
Without a culture of good governance rooted in progressive business ethics,
the right thing simply does not get done. Todays landmark documents of
business ethical behavior be it the OECD Anti-Bribery Convention, the UN
Convention against Corruption or the UN Global Compact reflect the
importance of ethics in conducting business and preventing corruption.
Good corporate governance is increasingly emerging not only as a tool that

increases efficiency, improves access to capital, and ensures sustainability

it is also emerging as an effective anti-corruption tool. Simply put, on the
day to day transaction level it makes bribes harder to give and harder to
conceal. At the decision-making level, it injects transparency and
accountability, so that it is very clear how executive decisions are made
and why.
Olympus scandal
Let us revisit the Olympus scandal of 2011, when one of the biggest and
longest-running loss-hiding arrangements in Japanese corporate history,
according to the Wall Street Journal, was exposed. The matter quickly
snowballed into a corporate corruption scandal over concealment of more
than 117.7 billion Yen ($1.5 billion) of investment losses and other dubious
fees and payments dating back to the late 1980s. By 2012 the scandal had
wiped 7580% off the companys stock market valuation, led to the
resignation of much of the Board and raised considerable concern over
Japans prevailing corporate governance and transparency. It even shamed
the Japanese financial markets globally.
Interestingly, The Economist said that the Olympus scandal is not an
accounting misdeedit is a mindset it is about the malleability of rules,
and the subjectivity of their enforcement. Until Japans institutions of
governancethose internal to the corporations, as well external regulators
and prosecutorschange, Japan cannot change. Similarly, we in Sri Lanka
withthe dawn of a new political era needa culture of good corporate
governance to erase the dilemma once in for all. Only a radical shift or
change in mindset will translate to a progressive change in business
practice, which in turn will establish and cement a culture of good corporate
governance.
Corruption
I firmly believe that without such a change corruption can never be
uprooted. Corruption has many faces and many moving parts. In some
instances business can be a source of corruption, in others it is simply a
victim. Corruption is a corrosive drain on public trust and on the legitimacy
of public and private sector institutions. Its toll can be devastating to a
national economy.

Corruption affects all types and sizes of business firms from global
conglomerates to Small and Medium-Sized Enterprises and co-operatives.
It has the power to destroy firms and with them the livelihoods of
stakeholders who depend on a companys success. This further
dehumanises and undermines the reputation of the private sector as a
positive force for economic growth and development, especially in
developing countries.
For in reality, predictable, competitive, and fair economic environments free
of corruption are central to sustainable business, economic growth and
national development. After all, the private sector can be a force in
developing solutions to the corruption problem, and companies around the
world are currently taking charge. They are doing it in multiple ways. Some
companies make their business environment more transparent. Others push
for ethical standards and fair practices in dealing with the government.
However, they all believe in an expanding culture of ethically founded
business practices.
The Tyco scandal
The Tyco scandal offers some major lessons to the business world on the
substance of good corporate governance. But it also stresses on the
necessity of a key factor, without which the essence of my presentation
cannot be fully understood. Without a strong and at times even
courageous leadership aculture of good governance or a progressive
system of ethics cannot exist; nor can the mindset of the corporate body be
geared towards acting on the right instead of the wrong.
The Corporate Leader paves the way to make this possible and today even
the UN Global Compact recognises this.
The fundamental component underlying much of what the best ethical
companies do is leadership. Leadership, made visible through actions,
commitment, and examples, sets the moral tone that emanates from the
top of a company, and that in turn, translates ethical principles into the
concrete behavior expected from all persons acting on behalf of a company.
In 2002, Tycos CEO and CFO were arrested and charged with
misappropriating more than $170 million from the company. They were also
accused of stealing more than $430 million through fraudulent sales of Tyco
stock and concealing the information from shareholders. To restore

investors faith, Tycos new management team reorganised the company

and recovered some of the funds that were misappropriated.
At its annual meeting, shareholders elected a new board of directors, voted
to make future executive severance agreements subject to shareholder
approval, and also voted that the Board Chair be an independent person
rather than a Tyco CEO. The company also hired Eric Pillmore as Vice
President of Corporate Governance. Pillmore was determined to revamp
Tycos ethical culture. Under his leadership, Tyco implemented a corporate
ethics program and replaced 90% of the headquarters staff.
The company also created the Tyco Guide to Ethical Conduct. Pillmore
worked to incorporate three elements into Tycos culture: 1) strong and
ethical corporate leadership; 2) accountability; and 3) behavior tracking
processes. He also created an ombudsman position at Tyco who can
mediate between employees and management.
It was outstanding that within a few years of being scandalised Tyco won
the award for Outstanding Improvement in Board Governance. Although
Eric Pillmore departed from Tyco in 2007, he won the honour of being one of
the 100 Most Influential People in Business Ethics.
Since the scandal, Tyco has been periodically reviewing employees and
business operations to identify areas of weakness. After one cultural
diagnostic survey revealed that ethics and compliance was taken more
seriously by top managers than the average employee, Tycos compliance
team implemented additional ethics talks for employees.
The company continues to restore a reputation for ethical conduct. In 2010
Tyco joined the World Economic Forum Partnering Against Corruption
Initiative to combat bribery. The companys successful comeback is
primarily attributed to strong and courageous leaders, who surmounted
adversity by focusing on a long-term financial plans centred on a groundbreaking ethical business model. In this model there is no dilemmano
drawing of lines. The corporate is now a conscientious citizen driven not by
executive greed and lets-get-it-done business pragmatism but by the
strong sense of doing the right thing.
Corruption is the enemy of development
PrathibaPatil the 12th President of India once stated that, corruption is the
enemy of developmentbe it in the corporate or the political world; in the

private or the public domain. Only good governance in all spheres of life
can help activate progressive ways of living and conducting business.
One of the key lessons I learnt from a Bernie Maddoff is that no personal
gain is worth risking the corporate brand and image forand that in the
long term, the paltry sand castle of corruption can never compare to the
lofty, luminous arches of good corporate governance.
(The writer, FCA, is Chairman Lanka Rating Agency, Deputy Chairman
Commercial Bank of Ceylon PLC, Group Director CIC Holdings PLC, Director
John Keells Foods PLC, Director EAP Holdings PLC and Deputy Chairman
Sri Lanka Institute of Directors.)