BUSINESS ETHICS, CORPORATE GOVERNANCE, AND CORPORATE REPUTATION

by Dr Rosamund Thomas Director Centre for Business and Public Sector Ethics, Cambridge, UK

Prepared for the Plenary Session 1 of The Reputation Institute Ninth International Conference Madrid, Spain 19th May 2005

Rosamund Thomas Tel: Fax: E-mail: Website: +44 (0)1223 357458 +44 (0)1223 303598 info@ethicscentre.org www.ethicscentre.org

BUSINESS ETHICS, CORPORATE GOVERNANCE, AND CORPORATE REPUTATION Paper by Dr Rosamund Thomas

CONTENTS 1

Page

BUSINESS ETHICS.1-2 1.1 What Business Ethics means.1

TYPES OF UNETHICAL PRACTICES AND BREAKDOWNS IN CORPORATE GOVERNANCE STANDARDS......2-3 2.1 2.2 WorldCom and Enron: US Corporate Scandals...........3-4 Equitable Life and MG Rover UK Corporate Cases..............................................4-7 2.2.1 Equitable Life...................................................................................................4 2.2.2 MG Rover.........................................................................................................5 2.3 2.4 Parmalat: The Italian Dairy and Food Company.....................................................7-9 France: The George Soros Insider Dealing Conviction.........................................9-10

REMEDIES TO STRENGTHEN CORPORATE GOVERNANCE AND BUSINESS ETHICS.............................................................................................................................10-13 3.1 3.2 3.3 The Sarbanes-Oxley Act of 2002...............................................................................10 The UK Combined Code on Corporate Governance, 2003........................................11 The OECD Principles of Corporate Governance, 2004.............................................12

CORPORATE GOVERNANCE ACHIEVERS AND BUSINESS ETHICS INITIATIVES...................................................................................................................14-16 4.1 4.2 The FTSE ISS Corporate Governance Index Series, 2004........................................14 The Fashion Industrys Business Ethics Initiative.....................................................14 4.2.1 Nike................................................................................................................15 4.2.2 The Fashion Industry Generally.....................................................................15

CONCLUSION......................................................................................................................16

1 1 BUSINESS ETHICS

First, I shall begin by drawing a distinction between Business Ethics and Corporate Social Responsibility. 1.1 WHAT BUSINESS ETHICS MEANS

Business Ethics emphasises morality, or ethical values, while Corporate Social Responsibility focuses, to a greater extent, on social and environmental performance. However, the two trends have converged, to a degree, with further responsibilities being added to both, such as human rights and anti-corruption. Numerous types of values exist, ranging from political values, such as democracy; economic values, including equity; social values like equal opportunity; and ethical values, such as trust; integrity; honesty; truthfulness; and others, which underlie Business Ethics and Ethics in Government. Unethical behaviour involves the opposites: distrust; deception; dishonesty; lying; greed; and so on. A Code of Ethics goes beyond separate values to become a set of principles that makes a clear statement of what the business corporation is willing to do, or not do, like forbidding staff to take bribes. Many different Codes of Ethics, or Conduct, now exist, ranging from those issued by international bodies, such as the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises1, to individual Codes adopted by different business corporations around the world. To define Business Ethics, then, it is made up of three main components:* * *
1

Ethical values; a Code of Ethics, and Good Corporate Governance

The OECD Guidelines for Multinational Enterprises (revised edition: Paris, OECD, 2000).

Corporate Governance2 is the framework for the policies and procedures which govern the Board of Directors in a business corporation, including non-executive directors and others who advise the Board. Corporate Governance is an essential part of Business Ethics since the morality of the Board and its individual directors does, or should, underlie these policies and procedures. For example, the remuneration of directors should reflect the values of fairness and honesty. In recent years, on the one hand, there has been a growth globally in establishing stricter Corporate Governance procedures, as well as the release in London in December 2004 of the new FTSE ISS Corporate Governance Index, which lists those business corporations with sound corporate governance principles.3 On the other hand, a number of high profile corporate scandals have occurred manifesting poor corporate governance standards, and other lapses in Business Ethics, including greed; lying; breaches of trust; conflicts of interest; a lack of transparency; insider dealings; and fraud by directors and others. Indeed, it can be argued that the stricter Corporate Governance procedures, to which I shall refer later, have been introduced as remedies to encourage higher ethical conduct in business corporations and to prevent white collar crime. 2 TYPES OF UNETHICAL PRACTICES AND BREAKDOWNS IN CORPORATE GOVERNANCE STANDARDS I shall look more closely now at some of the unethical, and sometimes also illegal, practices in business corporations. Corporate scandals are not restricted to any one country, or any particular business sector. They have arisen in the United States of America (WorldCom, Enron, and Martha
2

A fuller definition of Corporate Governance taken from the Revised Text, 2004, of the OECD Principles of Corporate Governance, (revised edition: Paris, OECD, 2004) p.11 is as follows:Corporate Governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders. Corporate Governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring. 3 FTSE ISS Corporate Governance Index Series (CGI) was established To raise the profile of companies achieving high standards of corporate governance. (London, FTSE ISS CGI, 13 December 2004) p.1. FTSE is the London based Index company and ISS is the Institutional Shareholder Services, with headquarters in Maryland, USA.

3 Stewart); in Italy (the Parmalat case); in the United Kingdom (Equitable Life and MG Rover); and France (George Soros market abuse conviction); to name a few. The corporate sectors involved in the aforementioned cases include telecommunications; energy; home furnishings; dairy foods, life assurance; car manufacturing, and others. While the stage of development of a country and its legal, regulatory, educational and religious systems have a bearing on standards of conduct, nonetheless there appears to be no particular pattern of ethical, or unethical, corporate behaviour in regard either to the countries or the corporate sectors involved other than the Transparency International Corruption tables and analyses of corporate standing by rating agencies. Therefore, from the range of corporate wrongdoings, I shall select a few for inspection of the unethical/illegal behaviour and corporate governance shortcomings. 2.1 WORLDCOM AND ENRON: US CORPORATE SCANDALS

Taking first WorldCom and Enron in the United States, Enron, the energy company, collapsed four years ago and WorldCom, the telecommunications group, less than a year later. Some argue that these two corporate scandals are extreme, making them unique departures from the norm.4 Even so, they led to the US Sarbanes-Oxley Act of 2002, which affects not only US corporations but also European and other businesses listed in the USA. Bernie Ebbers, the former Chief Executive of WorldCom, was found guilty by a New York jury in March 2005 of leading an $11 billion accounting fraud. The fraud caused the largest bankruptcy in US history. When sentenced in June 2005, Ebbers is expected to receive a prison sentence of twenty years or more. Some lawyers have argued that the outcome of the five-week trial could re-establish standards of corporate responsibility for Chief Executives, because jurors rejected Mr. Ebbers defence that he was unaware of criminal activities at WorldCom 5, in spite of serving as Chief Executive and receiving a large salary and bonuses. The jury recognised that fraud at WorldCom extended from the middle-management levels, up to its top Executive.
4 5

Ethical Corporation magazine, February 2005, p.20. See Financial Times, 16 March 2005.

During the course of the trial, the rise and fall of WorldCom was charted in the era of telecommunications deregulation. Bernie Ebbers was found guilty of manipulating the companys accounts in late 2000 in order to conceal mounting network expenses and to satisfy Wall Streets earnings expectations. As a result, WorldCom lost not only its corporate reputation, and the reputation of its former Chief Executive and Chief Financial Officer6, but also the entire business collapsed. In addition, Arthur Andersen, the global accounting firm, which was destroyed in the Enron scandal, recently reached a financial settlement with WorldCom investors, because the firm had overlooked evidence of fraud at WorldCom (one of its most prized audit clients)! It was argued that the fraud could have been stopped, if Andersen had been auditing with care, rather than looking to line its pockets.7 The WorldCom trial could have implications for the forthcoming trial of the former Chairman (Ken Lay) and Chief Executive (Jeffrey Skilling) at Enron.8 2.2 EQUITABLE LIFE AND MG ROVER: UK CORPORATE CASES

2.2.1 Equitable Life Equitable Life, the old established UK mutual Life Assurance Society, is suing currently in the High Court, London, fifteen former executives and non-executive directors9 for negligence and breach of duty, alleging that they should have taken legal advice before deciding to award differential terminal bonuses in 1996-1998. The controversial policy of differential terminal bonuses, (DTBP) was introduced at Equitable Life in 1993, before five of the nine non-executives being sued were on the Board. Some non-executive defendants say that they were being asked to spot for themselves an opaque item buried in technical documentation, and then question its legitimacy.
6

Scott Sullivan, WorldComs former Chief Financial Officer, pleaded guilty and became the US Governments key witness in the trial. 7 See Financial Times, 26 April 2005. 8 The trial of senior executives from Enrons bankrupt broadband division (Enron Broadband Services (EBS)) opened in Houston, Texas, in April 2005, but the trial of Jeffrey Skilling and Kenneth Lay at Enrons parent company, is scheduled for January 2006. 9 Six directors and nine non-executive directors.

The trial, estimated to last some nine months, will highlight the role of directors, and nonexecutives, and raise questions about the extent to which non-executive directors can rely on executive management, and how extensive their role has to be to avoid draconian litigation risks. Already it has been indicated that the Equitable experience is deterring non-executive director candidates from coming forward. Equitable Life is seeking damages of up to 1.7 billion from the directors. However, the claims against them do not suggest that they were dishonest: rather, negligent and failing in their duty.10 Furthermore Equitable Life is suing its former auditors, Ernst & Young, for negligence and breach of duty, alleging that the 1997-1999 accounts were deficient because they did not include proper provisions for guaranteed annuity rate (GAR) policies. The mutual is demanding 2.05 billion damages from Ernst & Young. Both the auditors and the directors strenuously deny the charges.11 The Society has been accused of gambling in this litigation its policyholders money in an attempt to offload blame for past commercial problems. Certainly, with the trial costs expected to reach some 85 million, if the mutual loses it would have to pay the defendants costs. Perhaps the unethical behaviour in this case is that the annual report shows the total pay for 2004 of the present Chief Executive, Charles Thomson, increased by almost 30% from the year before, while the costs of this litigation is putting the Society at risk financially.12 2.2.2 MG Rover At its peak Rover, the car manufacturer, played a key role in the British economy. However, in May 2000, Phoenix Venture Holdings (PVH), purchased the company from its then German owner,
10 11

See Financial Times, 11 April; 19 April; and 20 April 2005. Equitable Life nearly collapsed five years ago after losing a House of Lords test case over its controversial differential terminal bonus policy (DTBP). The current litigation involves further claims that in 1999 and 2000, after legal advice had been received, the Board failed to take steps to mitigate the risk of losing the DTBP test case and to inform policyholders of the danger. Equitable Life is also making further accusations against Ernst & Young. Financial Times, 11 April 2005. 12 The directors are reported as arguing inter alia a defence under Section 727 of the UK Companies Act, which gives courts the discretion to relieve directors who act honestly and reasonably of liability. This argument was used successfully in 2002 by Deloitte Touche, auditors, in their defence against an action of negligence in connection with the collapse of Barings Bank. See Financial Times, 11 and 15 April 2005. Therefore, Equitable Life faces a real risk in bringing this present action against its former directors and auditors.

6 BMW, for a nominal sum of 10, and MG Rover was created.13 The reason for the sale was that BMW had warned of closing UK car production at the Longbridge plant, Birmingham, West Midlands, unless a sale was secured rapidly. John Towers, the Chairman of the Phoenix Venture Holdings entity, the parent group, and the three other directors14, (known as the Phoenix four), are reported to have expected MG Rover to achieve a profit within two years. However, losses built up in the accounts of the Phoenix Holdings Group, and its numerous MG Rover, and other, subdivisions. To resolve this situation, a joint venture was discussed between MG Rover and the Shanghai Automotive Industry Corporation (SAIC), Chinas largest car manufacturer. However, after months of negotiations from 2004, and after gaining access to the accounting books of PVH, the Chinese corporation took fright, fearing a bankrupt joint venture! A British Government loan of 100 million was promised by the Prime Minister, Tony Blair M.P., but despite hopes of saving the company, MG Rover went into administration in April 2005, with PwC appointed as administrators.15 The gates of the Longbridge plant closed in mid April, with some 4,000 MG Rover workers losing their jobs and receiving only a small redundancy payment averaging 5,000 each. Small car dealers are said to face financial ruin as a result of the MG Rover collapse, and larger dealerships will experience losses. Much controversy surrounds the demise of MG Rover, including questions about whether the business was trading in insolvency prior to its collapse; possible flaws in the sale in 2004 by MG Rover to the Chinese car company (SAIC) of car and engine designs, in respect of the transfer of intellectual property rights, and whether the total of 67 million for the designs was underpriced; whether there was a black hole in the accounts of the Phoenix Holdings Group; and the state of the employees pension fund. Accordingly, the UK Department of Trade and Industry is to launch an investigation into the handling of MG Rovers finances by the Phoenix four.

13

Ford purchased Land Rover from BMW, which finalised the breaking up of the Rover Group. BMW purchased Rover from British Aerospace in 1994. 14 Messrs. Nick Stephenson, John Edwards and Peter Beale. 15 The British Government loan was not considered adequate to ensure MG Rovers survival. However, the Government has made other loans and payments to MG Rover, which ultimately will be financed by taxpayers.

7 Perhaps the most controversial issues surround the four directors and their remuneration, as well as their future gain of 6.1 million from a linked vehicle finance company16, even though MG Rover collapsed. A report published in September 2004 by the UK Parliamentary Trade and Industry Select Committee, had called for Phoenix Venture Holdings to find ways of promoting transparent good governance to dispel any doubts about how assets could be used in the future, and to emphasise sustainable car production as its core focus. A general view today is that the Phoenix directors were overpaid, with above average remuneration and substantial increases in their pension contributions from 2000 to 2003, while the main car business sustained heavy losses, with a hole opening up in the employees pension fund. Indeed, an independent inquiry by the UK Financial Reporting Council is attempting to establish how much money the directors took out of the group.17 Their behaviour may not be illegal or professional misconduct, but it is reported It may be that what has happened is unethical and greedy.18 2.3 PARMALAT: THE ITALIAN DAIRY AND FOOD COMPANY

The Parmalat company grew rapidly after its flotation to span some 30 countries from Italy to Brazil, China and the United States of America. Around 200 Parmalat subsidiaries added to the corporate complexity, as did offshore activities. The Parmalat founder, and former Chairman and Chief Executive, Signor Calisto Tanzi, sat on the Parmalat Board with other members of his family, Stefano Tanzi (his son), and Giovanni Tanzi (his brother). His niece, Paola Viscounti, had also been a Board member. Non-core businesses, such as the Parma football team, and travel operations, were part of the empire of the Tanzi family.19 At some point in this complex web of corporate activity, originating from Italy, a massive fraud is alleged to have been committed.

16

The vehicle finance company, MGR Capital Ltd., is a separate joint venture with HBOS bank, for car loans and leases. MGR Capital Ltd. sits outside the PVH Group. 17 Sir Bryan Nicholson, Chairman of the Financial Reporting Council, will report to the Government (the Trade and Industry Secretary). 18 See Financial Times, 18 April 2005. See also Financial Times, 19 April; 22 April; and 3 May 2005. 19 The Times (London) 27 May 2004.

8 Calisto Tanzi is reported to have admitted inventing huge cash reserves and faked revenues. In December 2003, the Parmalat empire collapsed, with huge debts, no cash, and leaving Italian and foreign investors holding worthless bonds. Numerous international banks involved in the sales of Parmalat bonds, and lending to the Parmalat group, are now facing law suits implicating them in the fraud. The banks are alleged to have been aware of Parmalats precarious finances, prior to its collapse, but to have continued to finance the company in exchange for large fees. Parmalats former auditors have also been accused of fraud, malpractice and negligence, for allegedly helping Parmalats former management to deceive investors about the true level of the companys assets and liabilities.20 Following investigations, Milan prosecutors have accepted plea bargains for nine out of twentyseven defendants involved in the Parmalat collapse, including three former Chief Financial Officers and two relatives of Calisto Tanzi, the founder. The plea bargains relate to charges of deceiving the market, obstructing regulators, and fraudulent auditing. The Milan prosecutors submitted the plea bargain arrangements to Judge Cesare Tacconi in April 2005, who is expected to decide whether to approve them by the next hearing of the case at the end of May. Calisto Tanzi, himself, has not reached a plea bargain deal. The defendants are also facing prosecution in Parma for bankruptcy fraud.21 In the United States of America, following a settlement of a civil action against Parmalat, the US Securities and Exchange Commission placed a requirement on the company of improved corporate governance, and the offloading of the non-core businesses, such as the Parma Football Team and travel operations.22 Enrico Bondi, Parmalats bankruptcy administrator, is intending to relist Parmalat on the Milan Stock Exchange, but the plans have been delayed by Italys financial regulator who has raised queries about the relaunch plans, and the companies prospectus.23 Unethical, as well as illegal, allegations abound in the Parmalat case, including deception, dishonesty, greed and self-interest. A major corporate governance weakness in this dairy/food
20 21

Financial Times, 8 March 2004; 17 July 2004; 7 and 12 August 2004. Financial Times, 7 April 2005. 22 Financial Times, 17 July 2004. 23 Financial Times, 1 April 2005.

9 group was the web of Tanzi family involvement and the corresponding lack of director independence. 2.4 FRANCE: THE GEORGE SOROS INSIDER DEALING CONVICTION

George Soros, the Hungarian-born investor, appealed in the Paris Appeal Court at a hearing in February 2005 against his earlier conviction in the lower court of insider dealing. He was fined 2.2 million24 for using privileged information in 1988 liable to affect the price of Socit Gnrales shares.25 Mr. Soros had been approached by an adviser to the French financier, Georges Pbereau, who was planning to take over Socit Gnrale in 1988. Mr. Soros had his Quantum Fund pay $50 million for shares in the bank, and in three newly privatised French companies. Socit Gnrales shares rose considerably and the takeover failed. Mr. Soros sold his shares at a profit which the court deemed to be insider dealing, dismissing Soros claim that the information was in the public domain and so not privileged. Mr. Soros lawyer said his client would appeal to Frances highest tribunal, la Cour de Cassation. Soros fears the insider dealing conviction will destroy his reputation.26 In another insider dealing case, Martha Stewart, then Chief Executive of Martha Stewart Living Omnimedia,27 was found guilty in New York in 2004 of lying during investigations.28 After a tip off from her stockbroker,29 she sold shares in 2001, before the price fell, in Imclone Systems, a drug company controlled by a friend. Ms Stewart was sentenced in July 2004 at the New York Federal Courthouse to five months in prison and other penalties.30
24 25

The fine is equivalent to the profits Mr. Soros made from the transaction. The court had found Mr. Soros guilty of exploiting precise, confidential information that was liable to affect the price of the banks shares. 26 See The Times (London), 25 March 2005. 27 A well-known home products, and cookery/design books/magazine, company. 28 The jury found Ms Stewart had lied twice to the FBI, and to security regulators investigating her sale of Imclone stock. She was found guilty of obstructing justice by attempting to cover up the reasons behind her stock sale and guilty of conspiracy. 29 Her stockbroker, Peter Bacanovic from Merrill Lynch, received the same sentence as Ms Stewart. See The Times (London), 24 July 2004. 30 Ms Stewarts sentence also included five months house arrest, and two years on probation (including the house arrest). At her sentencing, she is reported to have told the court: Today is a

10

The aforegoing cases are a selection from a range of defaults by business corporations; their individual directors; auditors; and bankers, which demonstrate how absences of business ethics and corporate governance standards adversely affect corporate and individual reputations. 3 REMEDIES TO STRENGTHEN CORPORATE GOVERNANCE AND BUSINESS ETHICS Of course, many examples of good corporate governance and business ethics exist, to which I shall refer later. Next, however, some remedies to strengthen corporate governance and business ethics will be identified. 3.1 THE SARBANES-OXLEY ACT OF 200231

Section 404 of the US Sarbanes-Oxley Act is regarded as the most costly and complex provision to meet. It comes into force on 15 July 2005. This section of the governance legislation covers internal controls against fraud, and requires companies to document, test and report on the effectiveness of their internal controls. Also, section 404 requires auditors to give separate opinions on the state of the controls. With the advent also of the new International Financial Reporting Standards, some US-listed companies, including US-listed European Union companies, are struggling with the requirements.32 Another key provision of the Sarbanes-Oxley Act, (Section 302), obliges Chief Executives to swear to the accuracy of their companys accounts. Accordingly, the ignorance defence attempted by Mr. Ebbers of WorldCom is less readily available. The Sarbanes-Oxley Act was a direct response in the United States of America to the Enron and WorldCom scandals. American reliance on legislation contrasts to the adoption of voluntary Codes shameful day for me and my family The scandal has spread like oil over a vast landscape and choked me, almost suffocated me to death. See The Times (London), 7 July 2004. 31 The Sarbanes-Oxley Act of 2002 (H.R. 3763, 107th Congress of the United States of America, 2nd Session, 2002). 32 Foreign companies, and the European Commission, have lobbied the US regulator (the Securities and Exchange Commission (SEC)) for extra time to comply with section 404 of the Sarbanes-Oxley Act. The SEC is expected to grant them the concession of extra time beyond 15 July 2005 to deal with this provision. See the Financial Times, 4 March; 15 and 25 April 2005.

11 of Corporate Governance in many other countries. Nonetheless, section 406 of the Sarbanes-Oxley Act requires a Code of Ethics for senior Financial Officers to be adopted. The Act defines the term Code of Ethics as such standards as are reasonably necessary to promote:(1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; (2) full, fair, accurate, timely and understandable disclosure in the periodic reports required to be filed by the issuer; and (3) 3.2 compliance with applicable governmental rules and regulations.

THE UK COMBINED CODE ON CORPORATE GOVERNANCE, 2003

The new UK Combined Code on Corporate Governance, which applies to UK-listed companies, replaces the earlier Combined Code issued by the Hampel Committee on Corporate Governance in June 1998. The Hampel Code, in turn, replaced the Cadbury Code.33 The latest Combined Code is based on a review by Derek Higgs of the role and effectiveness of non-executive directors,34 and a review of audit committees by a group led by Sir Robert Smith.35 It also includes guidance for directors on internal control produced by the Turnbull Committee in 1999.36

33

The Committee on Corporate Governance, chaired by Ronald Hampel, was established in 1995. It followed recommendations of the earlier Cadbury and Greenbury Committees that a new committee should review the implementation of their proposals. Mark Stock et al, KPMG, The Combined Code: A Practical Guide (London, Gee Publishing Ltd., 1999) p.1. 34 Review of the role and effectiveness of non-executive directors, published January 2003. More recently, a separate publication applies the Turnbull guidance to the US context to help non-US companies that are SEC registered. This publication The Turnbull guidance as an evaluation framework for the purposes of Section 404 (a) of the Sarbanes-Oxley Act was published by the Financial Reporting Council on 16 December 2004. The SEC has acknowledged the Turnbull guidance as one such suitable framework. 35 Audit Committees Combined Code Guidance, published January 2003. 36 Internal Control: Guidance for Directors on the Combined Code, published by the Institute of Chartered Accountants in England and Wales, September 1999.

12 The Combined Code is a set of Good Governance Principles and a Code of Best Practice (hence, Combined), which is tied into the London Stock Exchange Listing Rules. This UK approach of principles of corporate governance, rather than legislation, is intended purposely to be more flexible, applied with common sense and due regard to companies individual circumstances, and with an annual report explaining the application of the principles.37 The revised Code does not include the material in the previous Code on remuneration, as The Directors Remuneration Report Regulations 2002 are now in force.38 A formal assessment of how the revised Combined Code is being implemented will be carried out in the second half of 2005 by the independent UK regulator, the Financial Reporting Council (FRC).39 Informed assessments to date by the FRC have found that both investors and companies consider the corporate governance climate in the UK to have improved.40 However, the Equitable Life court action in 2005 against its directors and non-executive directors is likely to furnish information of its own on the role and effectiveness of non-executive directors! Spain, France and other individual countries have reviewed their Corporate Governance standards in order to raise awareness and performance. Spain, for example, has paid particular attention to conflicts of interest and the use of inside information by executives and directors. 3.3 THE OECD PRINCIPLES OF CORPORATE GOVERNANCE, 2004

The OECD Principles of Corporate Governance for publicly-traded companies41 were first endorsed by OECD Ministers in 1999, and have since become an international benchmark.42
37

Mark Stock et al, KPMG, op. cit. p.2. This is the comply or explain approach. The London Stock Exchange Listing Rules require listed companies to make a disclosure statement in two parts in relation to the Combined Code:- (1) the company has to report on how it applies the Principles and (2) confirm that it complies with the Codes provisions or where it does not to provide an explanation. 38 These Regulations require the directors of a company to prepare a remuneration report that is clear, transparent and understandable to shareholders. The Directors Remuneration Report Regulations 2002, S.I. number 1986. 39 The FRC publishes the revised Combined Code, 2003. 40 The 2003 Combined Code One Year On (London, Financial Reporting Council, 13 January 2005). 41 The OECD Principles, to an extent, are also deemed applicable to improve corporate governance in non-traded companies: for example, privately held and State-owned enterprises. 42 Since 1999 the Principles have formed the basis for corporate governance initiatives in both OECD and non-OECD countries.

13 In 2002, the OECD agreed to survey corporate governance developments in OECD countries and to re-assess the Principles. The result was that the Principles of Corporate Governance were deemed ready for revision to take into account new developments and concerns43 - these concerns obviously include court cases involving criminal corporate behaviour in a number of OECD countries, and the need to emphasise business ethics. The Foreword44 to the OECD revised Principles of Corporate Governance, 2004, states that they are intended to make criminal activity around the world more difficult and:will also help develop a culture of values for professional and ethical behaviour on which well functioning markets depend. Trust and integrity play an essential role in economic life 45 Other ethical, social and environmental concerns are treated more explicitly in the OECD Guidelines for Multinational Enterprises and the Convention on Combating Bribery of Foreign Public Officials in International Transactions.46 Taken together, these OECD instruments, if adhered to by business corporations, can remedy shortcomings in corporate governance and establish sound business ethics. Indeed, a range of other remedies have been advanced to improve corporate governance, to tackle white collar crime and to promote business ethics. These developments include the work of the World Council for Corporate Governance; European Union directives and company law reform studies; and reforms in individual countries.

43

The revision maintains a non-binding principles-based approach which recognises the varying legal, economic and cultural circumstances in OECD countries. 44 The Foreword is by the OECD Secretary-General, Donald J. Johnston. 45 OECD Principles of Corporate Governance (Paris, 2004), p.4. The Principles are not intended to substitute for government or private sector initiatives to develop more detailed best practice in corporate governance, p.11. 46 Another initiative to support the OECD and international concerns about corruption is the new DVD (and/or set of Videos) on Ethics and Anti-corruption, published recently by Centre for Business and Public Sector Ethics. Please see www.ethicscentre.org.

14 4 CORPORATE GOVERNANCE ACHIEVERS AND BUSINESS ETHICS INITIATIVES While a lack of business ethics and corporate governance failures were illustrated in the earlier cases, by contrast an innovative new Index series gives recognition to companies demonstrating sound corporate governance practices. 4.1 THE FTSE ISS CORPORATE GOVERNANCE INDEX SERIES, 2004

Launched in phases from December 2004 as a joint project between the FTSE Group, London, and the US Institutional Shareholder Services (ISS), the new Corporate Governance Index (CGI) Series has among its aims to raise the profile of companies achieving high standards of corporate governance. The Index series also seeks to raise the profile of corporate governance as an investment concern,47 so that best corporate governance performers can optimise their access to capital. The series design incorporates ISS corporate governance ratings into a financial index to aid professional investors and others. As a result, the financial performance of companies can be tracked against themes in corporate governance practice, including compensation systems for executives and non-executive directors; the structure and independence of the Board; and the independence and integrity of the audit process.48 Besides enhanced access to capital, the rewards for those companies selected to be listed on the new Corporate Governance Indexes include a positive reputation for corporate governance best practice. 4.2 THE FASHION INDUSTRYS BUSINESS ETHICS INITIATIVE

In the past fashion brands often have had a poor business ethics reputation due to sweatshop, child labour and other problems in developing countries. Both the fashion industry in the West, and in particular Nike, the sportswear group, have made strides recently to transform their corporate image and reputation49 into a positive ethical one.

47

FTSE ISS Corporate Governance Index Series (CGI) Index Design (London FTSE Ltd., 13 December 2004). 48 FTSE ISS Corporate Governance Index Series Home page on the website www.ftse.com. 49 Nike has been embarrassed in the past by allegations of exploitative labour practices by its contractors.

15 4.2.1 Nike Nike won support in 2004 from trade unionists and others for the companys ground-breaking decision to publish on its website the names and locations of more than seven hundred suppliers that manufacture its goods around the world. Nikes move in favour of transparency has been hailed as a new standard for social reporting.50 Problems still remain in factories in developing countries which supply the clothing and footwear industry, but it is hoped that other companies will follow Nikes efforts to be more transparent. 4.2.2 The Fashion Industry Generally Another fashion label placing ethical practices at the heart of its brand is Edun. The company, based in Dublin in the Irish Republic, produces organic cotton shirts and jeans. The cotton is not subsidised, so as to boost the economies of developing countries, where its products are made and sourced, particularly Africa.51 Edun is attempting to prove that ethical fashion is commercially viable.52 Other ethical fashion brands include US-based American Apparel which has grown rapidly since it introduced a no sweatshops policy two years ago. A leading British fashion designer, Katherine Hamnett, is to launch her own ethical range in Autumn 2005. Concerned about the economic and environmental damage caused by industrialised cotton production, she has assembled a new supply chain based on certified organic cotton and ethical manufacturing.53 It is expected that soon consumers opinions will force many fashion brands to use ethical practices more overtly in the brand communications. However, to avoid the criticism that being ethical is
50 51

The Financial Times, 19 April 2005. Eduns non-subsidised cotton comes from Peru and its quality fashion lines are manufactured in factories in Africa. Cotton used by many other companies comes from subsidised farmers in developed markets, such as the USA. 52 Respect is a key ethical value underlying Eduns brand: respect for people producing its products, for places where its products are made, for materials used, and for consumers. See the Financial Times, 19 April 2005. 53 The Financial Times, 19 April 2005.

16 simply a money-making policy, it is advocated that ethics in brand marketing should be controlled. For example, in the cosmetics industry, the origin of the Body Shops ethical stance was its specific pledge not to test its products on animals. Companies that are precise about ethics are said to be wiser than those making general claims about being ethical. Critics can pick holes in a general claim a product may be manufactured ethically, but what about every other aspect of business? Neither should ethics be used to create attention or grab headlines for what consumers are reported to want are brands they can take pride in. The former British Government Minister, Robin Cook, M.P., found a similar difficulty about making a general claim when he declared an ethical foreign policy for the UK Foreign and Commonwealth Office. This policy backfired as soon as a questionable practice arose in his Department! Other industries, about which I have written elsewhere, also taking an ethical approach, are, for example, the European Advertising Industry.54 5 CONCLUSION

Shareholder activism; the trend for investors engagement with companies; consumer awareness; pressure from non-governmental organisations, (NGOs); all combine with legal and voluntary Code remedies, to alert businesses to the importance of good corporate governance and business ethics. It is well known that a corporate reputation can be lost overnight. What is less appreciated is that a negative image can be changed as in the case of Nike in favour of an ethical reputation, if a company is prepared to be transparent, honest, and uphold high corporate governance practices. Certainly, the alternatives of imprisonment, or embarrassment, or a heavy fine, such as experienced by Bernie Ebbers; Martha Stewart; the Phoenix Four; the Tanzi family; George Soros; and others are not worth the individual or corporate risks they took.

54

Paper delivered by Dr Rosamund Thomas at an International Conference of the European Federation of Management Consulting Associations (FEACO) and the Hellenic Association of Management Consulting Firms (SESMA), held in Athens, Greece, October 2004.