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Chapter 5

Ethical Governance
To be effective, a Corporate Code of Conduct must be reinforced by a
comprehensive ethical culture.
Corporate Codes of Conduct should encourage employees to behave at
higher levels of Kohlbergs stages of moral development:
http://www.haverford.edu/psych/ddavis/p109g/kohlberg.stages.html
Organizational structures should be established to encourage and facilitate
individuals moving to higher levels of moral reasoning.
Each stage has a broader perspective than the one before regarding the
duties role, and obligations of the individual to society.
The final stage of Kohlbergs moral development hierarchy is where the
individual develops a principled conscience that adheres to moral and
social codes because the codes are guided by the same moral principals
that guide society.

TABLE 5.15
CODE GUIDANCE ALTERNATIVES
AND THE CONTROL/MOTIVATION SIGNALED
GUIDANCE PROVIDED

CONTROL/MOTIVATION SIGNALED

Obey these rules

Imposed Control

Seek advice before acting


Act on your best judgment,
but disclose what you have done
Guiding principles which indicate
this is what we are and what
we stand for
SOURCES: Clarkson & Deck, 1992, Clarkson, Deck & Leblanc, 1997.

Self-control

TABLE 5.8
ETHICAL CULTURE: IMPORTANT ASPECTS
An ethical culture combines formal and informal elements to guide
employee thought and action, including:
Ethical leadership by executives and supervisors*
Reward systems incorporate ethical considerations*
Perceived fairness, fair treatment of employees*
Open discussion of ethics in the organization*
Authority structure that emphasizes an employees accountability and
responsibility to question his or her own actions, and an obligation to
question authority when something seems wrong*
Organizational focus that communicates care for employees and the
community, rather than self interest
Official policies and procedures (code of ethics, practice, conduct)
Supporting offices (e.g. Ethics officer, ombudsperson)
Supporting structures (e.g. telephone hotline, whistleblower
protection, code sign-off, training, etc.)
* Most influential factors as found by Trevio et al. (1999)

TABLE 5.12
DEVELOPMENT AND MAINTENANCE OF AN ETHICAL CORPORATE CULTURE
STEP

PURPOSE

Assign responsibility:
Chairman or CEO
Ethics officer
Ethics committee

Successful initiatives usually involve:


top level accountability and adequate budget
champions, arbiters
monitoring, feedback, advice and cheerleading

Ethics Audit

To understand the organizations ethical practices, and its


network of stakeholders and interests

Ethics risk assessment

To identify important ethics problems that could arise (Ch6)

Top management support

Absolutely vital to successful adherence

Develop consensus on key ethical values

Necessary to frame policies and procedures

Develop code of conduct, ethical decision-making


criteria and protocols incl. sniff tests

Provide guidance for employees and all other stakeholders

Develop ethics program:


Leaders involvement
Launch
Training
Reinforcement policies:
Compliance Sign-off
Measurements of performance
Include in strategic objectives and managers objectives
Include in monitoring and reward structures
Communications programs
Exemplar award system
Ethics inquiry service
Crisis management

To successfully present and provide supporting


mechanisms for the guidance process

Establish a review mechanism

Information, investigation and whistle-blower protection


To ensure that ethics are part of survival reactions

TABLE 5.22
COMPARISON OF AGENCY THEORY & STEWARDSHIP THEORY
Agency Theory

Stewardship Theory

View of the individual

Economic agent

Complex & modern

Behavioral assumptions

Opportunistic wealth maximizer

Holistic & rounded view of


human nature

Behavioral characteristics

self-serving employees will


choose the options that are in
their own best interests
risk-averse there is an
increasing disutility for wealth
effort-averse employees will
shirk

want to contribute
will choose to do right
strive to achieve
like to innovate
want to do competent work
interested in a work-life balance

Management philosophy

Control-oriented

Involvement-oriented

Motivation

Extrinsic rewards

More intrinsic than extrinsic


rewards

Organizational identification

Low value commitment

High Commitment

Trust

Low employees are work


averse and so they will shirk

High stewards have an


inherent preference for honesty

Sources: James H. Davis, F. David Schoorman and Lex Donaldson, Toward a Stewardship Theory of Management,
Academy of Management Review 1997, Vol. 22, No. 1, 20-47, and Steven E. Salterio and Alan Webb, Honesty in
Accounting and Control: A Discussion of The Effect of Information Systems on Honesty in Managerial Reporting: A
Behavioral Perspective, Contemporary Accounting Research 2006, Vol. 23, No. 4, 919-932.

FIGURE 5.4
ALIGNING VALUES
FOR ETHICAL MOTIVATION & ACTION

Identification
Assessment
Rank

Stakeholder
Interests

Reports
Observations

Stakeholder
Evaluation

Corporate
Value System

Values
Transmission

Policies, Codes
Reinforcement

CORPORATE CULTURE
Created by Management
Leads to Corporate Actions

Actions

Motivation

Beliefs

Values

Other
Influences

TABLE 5.19
MECHANISMS FOR COMMPLIANCE ENCOURAGEMENT,
MONITORING, & REPORTING WRONGDOING
Compliance encouragement
Awards, bonuses
Inclusion in performance reviews, remuneration decisions, and promotion
Reprimands, suspension, demotion, fines, dismissal
Monitoring
Ethics audit or internal audit procedures
Reviews by legal department
Annual sign-off by all or some employees
Employee surveys
Facilitation of reporting of wrongdoing
Assurance of a fair hearing process
Protection: absolute confidentiality, whistle-blower protection plan
Counselling/information: ombudsperson program, hotline, human resources
Committee oversight assured: ethics committee of board, Audit Committee

TABLE 5.9
ETHICAL PROGRAMS USUAL DIMENSIONS
1. Formal ethics codes
2. Ethics committees developing policies, evaluating actions, investigating and
adjudicating policy violations
3. Ethics communications systems
4. Ethics officers or ombudspersons coordinating policies, providing
education or investigating allegations
5. Ethics training programs to raise awareness and help employees respond to
ethical problems
6. Disciplinary processes for unethical behavior

TABLE 5.13
DEPTHS OF CODE COVERAGE
Credo

Inspirational short statement on key values

Code of Ethics

Deals with ethics principles (short)

Code of Conduct

Deals with principles plus additional examples, etc

Code of Practice

Detailed rules of practice

TABLE 5.2
AREAS OF CORPORATE RISK ASSESSMENT
Governance and objectives
Areas of impact
Reputation
Assets, revenues, costs
Performance
Stakeholders
Sources of risk
Environmental
Strategic
Operational
Informational
Specific hazards
Degree of control over risklittle, some, great deal
Documentation

TABLE 5.7
ETHICS PROGRAM ORIENTATION TYPES
ORIENTATION

PRIMARY FOCUS

Compliance-based

Preventing, detecting, and punishing


violations of the law

Integrity or Values-based

Defines organizational values and


encourages employee commitment

Satisfaction of external
stakeholders

Improvement of image with and


relationships with external stakeholders
(customers, the community, suppliers)

Protect top management


from blame

Defensive CYA or cover your ___

Combinations of the above

Values- and compliance-based, for example

SOURCES: Trevio, Weaver, Gibson and Toffler, 1999, 135-139; Paine, 1994, 111; Badaracco & Webb, 1995, 15.

TABLE 5.1
CULTURAL VALUES AND HYPERNORMS
Sphere/Culture

Basis of Value-system

N. American

Rights-based: rights, justice, utility

Sino-Confucian

Duty-based: obligation to family

Japan

Duty-based: obligation to company

Middle East

Duty-based: obligation to savior

Europe

Personal rights

South America

Duty-based: obligation to family, religious values

Impact Exident On:


Dealing with people: hiring, gender;
Bribery;
Motivation for doing business;
Short- or long-term time horizons;
Importance of quality-of-life issues
Hypernorm Values:
Honesty, Fairness, Compassion, Integrity, Predictability, Responsibility

TABLE 5.16
SUBJECTS FOUND IN CODES
Ethical principles honesty, fairness, compassion, integrity, predictability, responsibility
Respect for stakeholder rights, and duties owed to each stakeholder
Vision, mission, and key policies tied into the above
Ethical decision making frameworks, sniff tests, rules of thumb, and guidance on making
tradeoffs between competing objectives
When to seek counsel, and whom to seek it from
Specific topics found in over 5% of employee, supplier and joint venture codes:
Bribery/improper payments or influences
Conflict of interest
Security of proprietary information
Receiving gifts
Discrimination/equal opportunity
Giving gifts
Environmental protection
Sexual harassment
Antitrust
Workplace safety
SOURCE

Political activities
Community relations
Confidentiality of personal information
Human rights
Employee privacy
Whistle-blowing and protection programs
Substance abuse
Nepotism
Child labour

: The Conference Board Research Report, Global Corporate Ethics Practices, 1999, 29.

FIGURE 5.2
STAKEHOLDER ACCOUNTABILITY ORIENTED GOVERNANCE PROCESS
SHAREHOLDERS + OTHER STAKEHOLDERS
PUBLIC INTEREST

All Interests

Accountability = Financial & Strategic


including
Ethical & Legal

BOARD OF DIRECTORS
Sets

External
Auditors

Vision, Mission,
Strategy, Policies,
Codes, Compliance,
Feedback,
Compensation

Lawyers

Appoints CEO, CFO

Guidance

Feedback

CORPORATE CULTURE
Created by Management
Leads to Corporate Actions

WhistleBlowers

Financial
Reports

Ethics
Officer

Professional
Accountants
Including
Internal Auditors

FIGURE 5.1
MAP OF CORPORATE STAKEHOLDER ACCOUNTABILITY
Shareholders

Activists

Governments
Lenders &
Creditors
Competitors

Employees

Corporation

Customers

Suppliers
Others, including the Media,
who can be affected by or who can
affect the achievement of the
corporations objectives

FIGURE 5.3
STAKEHOLDER INTERESTS RANKING, RISK ASSESSMENT, & USAGE

SHAREHOLDERS + OTHER STAKEHOLDERS


PUBLIC INTEREST
Accountability =

All Interests

CORPORATE RISK ASSESSMENT

Identify All
Stakeholders

Assess & Rank


All Interests

BOARD OF DIRECTORS
Sets

Integrate
Into Corporate
Value System
& Actions

Vision, Mission,
Strategy, Policies,
Codes, Compliance,
Feedback,
Compensation

Appoints CEO, CFO

Prepared by management for Board review and approval

Guidance

CORPORATE CULTURE
Created by Management
Leads to Corporate Actions

Actions

Financial & Strategic


including Ethical & Legal

Motivation

Beliefs

Values

Feedback

TABLE 5.3
ETHICS RISK MANAGEMENT PRINCIPLES
Normal definitions of risk are too narrow for
Stakeholder-oriented accountability and governance
An ethics risk exists where
the expectations of a stakeholder may not be met.
Discovery and remediation are essential in order to
avoid a crisis, or lose the support of stakeholders.
Assign responsibility, develop annual processes, board review

TABLE 5.4
CONFLICTING INTERESTS CAUSES OF JUDGEMENT BIAS
How might judgement be swayed
Any interest, influence, loyalty, concern, emotion, or other feature
tending to make judgement less reliable than normal
Self-interest
Bribes, kickbacks payments or property to decider, family, designees
Gifts, free travel, favors,
Special advantages non-market discounts on goods
Special treatment flattery, social involvement
Dealings with family, relatives or relations
Fraud ...
Misappropriation of funds or property
Cheating on expense accounts
Falsifying documents
Stealing cash, assets, or resources
Falsifying results to obtain bonuses, merit pay, or promotion
Misunderstanding
Confused signals or incentives
Boss/everybodys doing it
Cultural differences
Slippery slope
Where a small favor leads to ever larger demands

TABLE 5.6
GUIDELINES FOR ACCEPTANCE OF GIFTS OR PREFERENTIAL TREATMENT
1. Is it nominal or substantial?
2. What is the intended purpose?
3. What are the circumstances?
4. What is the position of sensitivity of the recipient?
5. What is the accepted practice?
6. What is the firm/company policy?
7. Is it legal?

FIGURE 5.5
CONFLICT OF INTEREST FOR A DECISION MAKER
A decision maker (D) has a conflict of interest if, and only if,
(1) D is in a relationship with another (P) requiring D
to exercise judgement in Ps behalf and
(2) D has a special interest tending to interfere with the
proper exercise of judgement in that relationship.
Special
Non-P Interests
Decision Maker
(D) has a duty to
act/judge in
Ps best interest

Ps Satisfaction
based on
Fulfillment of
Ps Interests

FIGURE 5.6
TYPES OF CONFLICT OF INTEREST

Potential

Actual

Decision Point
Non-existent

Apparent

Imaginary

TABLE 5.5
MANAGEMENT OF CONFLICTING INTERESTS
Steps To Be Taken
Ensure awareness through:
Codes of conduct and
Related initial and ongoing training
Create a program and an understanding of:
Employers concerns regarding conflict of interests
Major issues:
Avoidance is preferable
Slippery slope
Management techniques:
Annual sign-off, confirmation review and compliance
Guidelines for gifts, behavior
Counseling, reporting, reinforcement
Chinese walls/firewalls, scrutiny

TABLE 5.17
EXTERNAL SHOCKS AND INFLUENCES TRIGGERING CODE MODIFICATION
Anti-bribery legislation U.S. Foreign Corrupt Practices Act of 1977
This Act provided an early motivation for codes
U.S. Sentencing Guidelines of 1991
Brought provision for Due Diligence defense
Environmental responsibility:
Acid rain, air pollution, ozone depletion
(U.N. Brundtland Commission Report of 1987)
New Environmental Protection statutes
Exxon Valdez oil tanker spill triggers Valdez (now CERES) Principles
Fair treatment for:
Employees:
Feminism: sexual harassment, equal opportunity for pay and promotion
Minorities: discrimination*
Health, safety and well-being
Supplier employees no sweat shop or child labor
Drug problems privacy vs. safety
Whistle-blowers**
Customers buyer beware slowly becomes seller beware
Health & safety concerns auto recalls (see Ford, Firestone case)
Ethical consumerism, quality
Shareholders:
Misuse of inside information
Conflict of interests
Mandate and operations are ethical Enrons banks engage in transactions without economic substance
designed to mislead
* See Ethics Case: Texacos Jelly Beans in Chapter 7.
** See GE case described in reading by Andrew Singer in Chapter 1.

TABLE 5.18
ESSENTIAL FEATURES TO DEMONSTRATE A
DUE DILIGENCE DEFENCE IN RESPECT OF ENVIRONMENTAL MATTERS
1. A written environmental policy, made known to appropriate employees
2. Operating practices which guard against environmental malfeasance, including contingency plans to
cover mishaps to ensure full scale, timely clean-up
3. Employees briefed on their duties and responsibilities under the policy, as well as their potential
personal liability, and the liability of others
4. Employees informed of legal requirements, including notice to government complete with a contact
list
5. A person who is primarily responsible for environmental matters and monitoring compliance
6. Consideration of an environmental audit or consultation with an expert to start the protection
process and monitor progress
7. Monitor pollution control systems and report mishaps on a timely basis
8. Regularly review reports on compliance, potential problems environmental charges, conviction and
employee training
9. Management that keeps abreast of new legislation, makes an internal review of compliance and
advise directors of the results, and allocates a real and satisfactory budget to achieve these features

FIGURE 5.8
EXECUTIVE REPUTATION & ETHICAL LEADERSHIP

MORAL MANAGER

MORAL PERSON
Weak

Strong

Strong

Hypocritical

Ethical Leader

Weak

Unethical
Leader
Ethically Neutral Leader
Source: Moral Person and Moral Manager: How Executives Develop a Reputation for Ethical Leadership,
L.K. Trevio et al, California Management Review, Vol. 42, No. 4, Summer 2000. Reprinted with permission.