The Year that was...

As the year draws to a close, let us take stock of what happened in the sphere of Corporate Governance and Business Ethics in 2009. Did we make enough progress on these fronts, were there any new developments that have taken us forward, did we do enough to bring new energy and thought to these disciplines? Relevant questions indeed.

As I scan the last 12 months, what stand out are the large governance failures. We felt the full blast of the sub-prime. Many argue that the sub-prime is not a governance or ethical issue, but one of business failure. I beg to disagree. A system that is driven by greed and enriches a small group of senior employees in financial firms at the expense of millions of people worldwide can be anything but a governance failure. We also had large corporate debacles like Satyam in India. Indifference to the principle of conflict of interest lies at the core of both these examples. Familiar words that ring a bell that sounds Enron...Enron...Worldcom....Worldcom... That was almost a decade back!

Despite the large scale impact of the sub-prime, we have not seen enough thought given to governance reform to prevent a relapse. While discrete cases like Enron and Worldcom invited a high level of introspection on governance, one feels sad that the governance aspects of the sub-prime have been forgotten in the rush to bail out economies. Is there enough study to understand how the risks underlying the mortgage-based securities were not analysed by Boards, Audit Committees and Auditors? Is there enough investigation of who failed and why? How much of a role did the greed for higher compensation play in the whole drama?

A governance institution that has taken a severe dent to its reputation during this year is that of the Audit Committee. Top minds and talent sitting on the Audit Committee of Satyam Computers had no clue of what was brewing. Sitting on an Audit Committee has become similar to a marine fighting in the outback of Kandahar, one does not know what will hit you and when.

The concept of the Audit Committee is laudable and we do not have any potential replacement for the concept in sight. However, the way Audit Committees work needs major overhaul if they are not to be seen by investors as watchdogs that can neither bark nor bite. A serious examination is needed of why Audit Committees with top-class intellectuals tend to fail time and again. Very little happened on this front this year.

On balance, a year of missed opportunities.

Lifting the Corporate Ethics Veil

Sometime back I wrote a blog about testing the Ethical Quotient of job applicants. The occasion was the action by an Infosys employee who called up the Delhi airport with a hoax bomb threat because he was delayed for a flight. He was arrested and I guess also sacked by the firm.

Today I read a very disturbing news item about an Infosys employee who, along with his wife, was arrested for alleged physical and mental abuse of a 14 year old girl who they had hired as a household help in Bangalore. So within a year, we have two incidents of personal misconduct of its employees that has placed the IT major in the public eye. Coming on the cusp of the year of the Child's Rights, this is a situation the company would have liked to avoid. Lets face it, a hoax bomb call is like a prank compared to abuse of a girl child. It is equally ironical and sad that a highly reputed company like Infosys has to go through this.

I am not going to write here again about the need for screening of potential employees and psychometric testing, because my point of view seems amply vindicated. What I would like to discuss is the issue of the Corporate Ethics veil - and where it needs to be lifted perhaps. I use child labour as an example, as it is both stark and contextual. Having worked in a manufacturing environment all my life I know that the potential risk of child labour is high in such companies - third party manufacturers, factory maintenance contractors, etc etc. But in a Knowledge-based industry like IT, the risk of child labour within the firm is rather limited. Obviously none of its employees can be children. They hardly have third party manufacturers. Vendors and service providers are verified and audited.

The highest risk of child labour in such a corporation then stems from its employees using children to work at home. Being double income families and frequent travellers, the employees often need someone to take care of their own kids. Child labour is cheap, obedient and doesn't talk back. I have IT employees as neighbours and many of them use girls who are 14 and below to take care of their kids.

What I would like to see is affirmative action from companies on two counts. One is to expand the scope of avoidance of child labour by the firm (usually a part of their Code of Ethics document), to include prohibition of such practices by employees in their personal capacity. The second is to make this a punishable offence on detection and back this by declarations from employees. This is what I meant by lifting the corporate ethics veil.

We live in an information era where adverse news spreads in a matter of seconds. Readers are not legal experts to discern what the limits of corporate responsibility are. Voluntary lifting of the corporate ethics veil protects the firm from reputation risks, especially on highly sensitive aspects like child labour.

Wish you all a happy 2010.

Catch 22

Joseph Heller wrote the novel Catch 22 in 1962. It was a time when people started their careers in, and retired from, the same company. Variable pay was a remuneration practice limited to salesmen. Stock options were as far away from human imagination as the Internet. So Heller had to write a whole book on the concept called Catch 22. It caught the fancy of the world and the term became synonymous with "a situation from which there was no escape as it involved mutually conflicting or dependent conditions (Oxford English dictionary)".

If 1962 was fast forwarded to 2002, Heller would not have had to write a whole book on Catch 22. All he had to do was to direct people's attention to the listing requirements of stock exchanges that need quarterly disclosure of financial results.

All pundits of Business Ethics and Corporate Governance are unanimous that good governance is about thinking and working long term. They argue vehemently against short-term styles of management as these go against the interests of the shareholders and investors. They view PE-owned companies with circumspection for the same reason. Common sense and intuition indicate that these views are valid and have a lot of truth in them. How come we got into into the quagmire of quarterly reporting? To protect investors indeed.

Quarterly reporting started as an investor friendly devise meant to minimise potential shocks being delivered at the end of the year. Instead it has become the root cause of major governance earthquakes. Managements run from quarter to quarter trying to improve on the previous ones. Revenues are over-stated and costs understated. This sets in a motion a spiral that moves only upwards as more fabrication is needed to grow on an already fabricated base. R&D investments are cut back and new launches withdrawn from store shelves if they do not succeed within two months. Innovative financial derivatives are created to boost profits and phenomena like sub-prime make Enron and Worldcom look like small time tricksters.

In this quarterly circus, the analysts and stock market gurus wield enormous power. They can either dump a stock based on one bad quarter, or play God and give the company a few more quarters to perform. They love phrases like "the long-term is the aggregation of quarters" or "in the long-term everyone is dead". In this scenario, a company that says that it has an excellent long-term plan but the outlook for the next few quarters is poor would be like a piece of meat in front of a hungry lion. So what is a manager supposed to do in this situation, except focus on the short term?

Would you think that stock market regulators are not aware of these stark issues. Of course they do. Can they think of moving the reporting to once a year instead of quarterly? Of course not, we live in a global information age where a year is too long and stock markets would lose their dynamism in that case. Can the reporting evolve into a combination of long and short term performance indicators? No, this becomes too subjective and complicated to monitor.

We seem totally bound by a requirement we have invented. Can one think of a better example for illustrating Catch 22?

Footnote: Unlike in Heller's novel, the characters in this drama are not fictitious.

Building the Ethical Ethos

I recently had a dinner meeting with an experienced compliance professional and we got to discussing Indian companies that were known for their values. I gave him the experience of my teaching Business Ethics at a B School for 3 years where, in the opening session, I would ask students to name companies that in their perception were known for ethical behaviour. Each successive batch voted the Tatas as the most ethical Indian corporate. He then asked me how a diverse group like the Tatas manages to build and sustain an ethical ethos.

From my personal experience of working in India for a highly ethical corporate, there are four key aspects that set companies like the Tatas apart from the others.

The first and foremost is exceptional ethical leadership at the very top. Leaders like JRD and Ratan Tata have radiated righteousness at all times, shaping the attitudes of their senior managers and business heads continuously. The business leaders in turn act as role models for the rank and file. A remarkable demonstration of this value percolation is the way each and every employee of the Taj Mumbai reacted during the 26 Nov crisis, putting the safety of guests ahead of their own. In my opinion, there has been no greater demonstration of business ethics than this in corporate history. Consistent and persistent ethical role modelling at each layer of the organisation can do what no number of training sessions can achieve.

The second factor is the age and experience profile of senior management. In business houses like the Tatas the CEOs and Board members of group companies are normally in their 50s, and have spent long years in the company. They know that the only way to reach the top is by demonstrating 'sustainable' performance, as opposed to the focus on short term performance in many new age companies. This implicitly fosters responsible behaviour towards all stakeholders. If you look around the world at major governance lapses, you will invariably find people involved who have grown too fast and too early in life. BE has a lot to do with experience, and the unfortunate truth is this cannot be fast tracked.

The third factor is perhaps the most important. Employees in these companies know that they will not be faulted for the business consequences of ethical behaviour. To the contrary, they know that the organisation will stand by them in such situations. I was once the Commercial Manager of our manufacturing unit in Jammu, and we had a holiday home for executives in the beautiful city of Srinagar. I got a demand from a senior Government official to stay in the holiday home, that I refused. Soon thereafter, we had cases filed against the company demanding huge amounts for non-compliances that we were not guilty of. We had to go through long legal battles to extricate ourselves, but at no point was I faulted for the situation we were in. This is a tough attribute for a business to build, especially when it comes to pressures around revenue targets, product launches and investor expectations. On the contrary, if in such a situation the superior says "I need results and not excuses", the subordinate is very likely to go back and break the rules.

The last but most subtle factor is peer pressure. There is a sense of pride and belonging to the ethical ethos in these companies, that people who step out of line are ostracised by their peers and feel quite like a naked person on Oxford Street. Rotten apples do appear once in a while, but are quickly ejected from the system. I have seen this peer pressure operating at all levels right down to the shop floor, and the way erring employees work hard to regain the respect of their colleagues.

It has been a long blog, but building an ethical ethos takes long and sustained effort, and a short blog would be rather unjust to the topic.

Business Ethics: An All or Nothing Game?

The classical definition of BE is that of an "All or Nothing" game, if one can be pardoned for using this term for a topic that is least playful. This means that a company does not have the liberty of being ethical in some of its activities and not in others. The rationale for this classical approach is that there can be no such thing as 'somewhat ethical' or 'partially ethical'. I have the fullest respect for this view, but at the same time feel that it merits serious examination.

Businesses in developing countries face a number of ethical challenges. In a scenario where watchdog bodies are few (and those that exist focus mostly on European and US multinationals), local companies have a free run as far as ethical behaviour is concerned. In this environment, companies that adhere to higher standards of behaviour are actually at a distinct disadvantage vis-a-vis their peers that do not. This then begs the question whether companies that demonstrate good business principles at least towards some of their important stakeholders, if not all, are better than those that do not do much at all. These companies at least have the opportunity to test the unchartered territory of ethics and get their feet wet. The chances of a positive rub-off effect on their other operations then become bright.

We could then start prioritising what is inviolable and what is tolerable. Aspects to do with safety of employees and consumers, human rights, obeying the law and reporting transparency should obviously be totally inviolable. There would then be aspects like fair competition and facilitating payments that come lower down the criticality scale and could be expected to kick-in in due course. Issues like child labour, counterfeits and unsafe working conditions are far more critical and acute in these economies than those like price fixing that in any case happen widely in these under-regulated markets. So we could actually have businesses that may be called "mostly ethical" if they conform to what is inviolable.

Achieving 100% ethical compliance is as difficult a goal as total nuclear disarmament, even in the most developed of economies. What I am talking about is non-proliferation of unethical behaviour and a gradual containment, in far less-privileged markets. It is a unconventional point of view. But then this is the newfound age of unconventional thinking, thanks to the new President in the White House.

Time for HR to Act

Today's newspapers carried an interesting headline about an employee of Infosys (the Bangalore-based IT major) who realised that he was late for a flight and called up the airport at Delhi with a hoax bomb threat in order to delay the flight. The police were waiting for him at the airport and promptly arrested him. The highly respected IT company must have been quite embarassed by this incident. Equally, readers were surprised that an Infosys employee could have done something like this.
Despite training initiatives on ethics, all companies have employees who like to tread the thin ice when it comes to the right and the wrong. These are clever people who know how the system works and how to manipulate the system. Obviously educating them on BE is like pouring water on a hard rock. So how can a company identify and weed out such employees?
As the saying goes, a job well begun is half done. So the right place to filter persons who have a propensity for dabbling with reputation risks is at the time of recruitment. Unfortuately, psychometric tests focus mostly on job-oriented behaviour patterns like team working, leadership, decision making, etc and hardly on the ethical quotient of candidates. What companies need urgently are psychometric tests that can provide good indicators of the ethical mindsets of the people they wish to employ.
Profiling mechanisms for identifying growth and leadership potential of employees rarely include ethical parameters. So do performance appraisals. We know that recognising performance or potential that was short on ethical aspects has been at the root of most corporate scams of recent years. HR specialists argue that ethical behaviour is not included in formal appraisals since this is taken as a given. We have a nice proverb in my native language that says "The cat closes its eyes and imagines that the entire world is asleep" !!
It's time for HR to take greater accountablity for bringing some fundamental changes in the management of the people aspects of Business Ethics.

Sleeping with the Enemy

I went to a Hyundai show room last week to look for a new car for my mother. The salesman asked me what car I drove, and I said I drive a Suzuki Baleno. Surprisingly, he said he also drove a Baleno and found the car to be very good. He added that another of his colleagues in the same showroom also drove a Suzuki Baleno.
One of the classic dilemmas in Business Ethics is whether it is ethical for a company's employee to use products of a competitor, and on the other hand can companies insist that employees avoid such behaviour. Fortunately, this is one of the more light-hearted BE dilemmas and quite interesting to delve in. Let us look at a few scenarios.
Can a Toyota salesperson be seen driving a Honda Civic? Can a Philips manager have a Sony Plasma TV in her drawing room? These are visible demonstrations, and hence one can argue that they are potentially more harmful to the brands that they work for. What then about usage that is less visible, like a P&G Marketing Manager using Colgate tooth paste in his bathroom, or a Mr Turner working for Microsoft having a personal email account id called turncoat@gmail.com? Or the mother of all offences - a Coke manager drinking Pepsi while watering her garden? Is visible consumption of competitor products a greater sin than less visible ones? There is of course a third dimension that seems acceptable - which is the use of a competitor product to check it out - like a Lufthansa sales executive flying BA to check out if his company is giving away too much legroom compared to the British airline.
And can companies prohibit or discourage employees from using competitor products?
There are no easy answers to these questions, and in my experience I have not seen any formal policies on these aspects. The accepted position seems that companies do not have a right to prevent employees from being customers of a competitor, as it would be seen as interfering with their fundamental rights. This sounds rather unfair on the companies, but is the expected stance from an ethical organisation.
Unfortunately, most discussions on BE focus on the responsibilities of the organisation towards its stakeholders, with limited discussion on the reverse. In my view, an employee should not be using a competitor's product if it is going to lead to a clear conflict of interest that in turn is likely to harm the company's reputation. Like the Hyundai salesman driving around in a Suzuki. And I also feel senior managers of a company should not be using competitor products as they are seen by the outside world to be representing what the company stands for. This may sound old-fashioned, but in the olden days these were unwritten rules that everyone followed.
Of course I would be less worried if a Pepsi shop floor worker drinks Coke while on vacation, or a Sony clerk buys a Samsung handycam as it is 30% cheaper. Having a lower-paying job has its advantages sometimes, and freedom of choice may be one of them!

Separating men from mercenaries

The ability to learn from mistakes and not to repeat them is perhaps the most important requirement of any good governance mechanism. Unfortunately, this is sorely neglected by corporates and regulators alike. How else can we explain the sub-prime fiasco, when we had Enron to learn from?
The root cause of both crises was the unbridled greed of top management, reflected by insanely high compensations. Today, a top corporate executive anywhere in the world earns several times what a good surgeon or teacher earns. In fact, what the Chief of the Indian Army earns in a year is probably less than what the CEO of any of the top 100 Indian companies earns in a month. Now to imagine that a CEO has greater responsibilities or IQ than the Chief of the Army is not unexpected of corporate egotism!
I agree that if corporates are self-funded they legally have the right to pay their CEOs whatever they like, even though the morality and social justice of this would be questionable. But at a time when the free market across the world is being pulled out of the ICU by the State using tax payer's money, the question to answer is whether enough is being done in the form of regulation to rein in top management wages. As rescuers, the State and the public have a right to insist on such regulation. Sadly we do not see enough focus on this, and my fear is that history will repeat itself.
Effective regulation over managerial remuneration should include aspects like fair distribution between short-term and long-term rewards, limits on the multiple between wages of the top management and the lower levels, and equity between corporate wages and remuneration in other comparable sectors of the society. I would like to see if any progressive corporates have the courage to come out with affirmative action on this. That would certainly separate the men from the mercenaries.

Corporate Reputation

Someone asked me the other day "How does a corporate build its reputation?". It was a seemingly simple question, as any number of books on the subject have a ready answer - build transparency, accountability and good governance - and your reputation shall grow. Let us step back for a moment and think, how many people in an organisation would know what the activity of building transparency, accountability and governance means or involves, and what their role in this activity is? Would the Purchasing Clerk or the Salesman empathise with it? Often times the problem with Business Ethics is that we place it on a very high pedestal and make it sound more complicated than it really is.
In simple terms, corporate reputation is built or otherwise every time there is an interaction between a stakeholder and the organisation. If each of these interactions is based on the principles of respect, fairness and mutual benefit, reputation grows. When a Salesman responds promptly to the complaint of a shop keeper in a small town, he is demonstrating respect. When the Purchase executive ensures that there is a transparent tendering process, he demonstrates fairness. When a Purchase manager shares the annual requirement with a vendor, he is emphasising on the principle of mutual benefit. These are simple principles for anyone in the organisation to relate to.
The key here is that every interaction counts. The net impact is something like a credit card account. When you spend on the card, you get reward points. These add up slowly over time. When you miss a payment, you get a big charge on your card. The penalty for delayed payments is much higher than the reward points for spending. Sometimes it takes a series of non-payments to get your card cancelled, but sometimes one large default may do the damage.

Diversity - More Talk than Walk

A few days back I read with total astonishment a news item about a study by a leading UK University that tries to establish that companies with more female Board members have lower stock market valuations. I thought, how ridiculous can this get?
I have been working on an article about diversity in senior corporate management for a while now. The facts that I find are immensely interesting. A large number of companies worldwide talk about diversity being a major focus. But the average representation of women on Boards is around 20% in the US, 10% in Europe and 5% in India. More importantly, in most cases these are independent and non-executive Directors (only 3 of the 15 large US companies in my sample have Executive women Directors on their Boards).
I then looked at the composition of Management Committees and that is where this gets more bizarre. A large number of major global companies have no women on their Executive Committees and the overall average is well below 10%. I would not like to name these companies , but the information is readily available on their web sites.
We all say that Governance is about setting the tone at the top, and walking the talk. But when it comes to diversity Corporates seem to have a severe problem of cold feet while walking all that masculine talk. To blame women Directors for stock market valuations in a situation where they have not been given a fair opportunity to Govern is grossly unjust. I thought the British were known for their chivalry!

Of Apples and Oranges

It is amazing how many people think that Business Ethics (BE) and Corporate Governance (CG) are one and the same. I mean professionals in industry, academicians, etc. They tell you that they follow the latest CG norms, and hence are ethical. Comparing apples and oranges is slightly better, both are fruits, both are sweet and good sources of vitamin C!
There are three major differences between CG and BE. The former largely involves complying with what is legislated, while BE is largely about following what is not legislated (enforcing the unenforceable). Take a simple case in point. When a business in trouble restructures, it could legally retrench surplus headcount by giving notice and paying compensation as provided in the employment contract. Business ethics is about looking beyond this - counselling the employees, actively helping them get outplaced, helping them get re-skilled, etc. Few companies do this - who would repair a car before selling it?
Second, CG is meant mainly to meet the transparency criteria for publicly listed companies. Imagine a 5-bedroom villa. CG is its living room, where a large number of guests are entertained. The room is nicely carpeted, cracks in the wall covered by replicas of vintage artists and the door handles polished once a month. BE is like the last three bedrooms. How often have you strayed into a host's house beyond the living room, to be told "sorry, we are just back from a trip, so its all in a mess", when you can see that the mess is several trips old. A private firm or a PE managed firm is like a villa without a living room, they get very few guests and manage with a couple of sofas in the foyer!
The third difference is of recent origin, and very stark. CG is about keeping your top management out of court, and most importantly out of jail. BE is about keeping your business in business over the long run. Now that is a difference that very few people should have difficulty in appreciating.
So much for now.

Legislating Compliance vs Legislating Transformation

The art of good legislation is knowing what to legislate. Every time there has been a corporate scam, we have rushed to legislate compliance, only to be followed by a smarter scam. Corporates hire people whose job is to go around legislation, and they pay them a lot for doing this. Legislators are paid far less, and are always working on hindsight. The British call it shutting the stable after the horse has bolted.
If I were a legislator, I would focus on transformation of the ethical culture. I would legislate the teaching of business ethics as a mandatory foundation subject to all B School graduates. One would be surprised how few B Schools teach Business Ethics as a separate subject (I mean core business ethics, not Business Laws or Corporate Governance laws). It needs a Dean with a lot of foresight and courage to accomodate BE in a curriculum that is crowded with job-oriented themes (my good friend Prof Sudarshan is one of these few). At least a few of them have the honesty to admit that BE is not going to help their students land jobs.
Teaching students the nuances of business ethics would help them, when they join the mainstream, to discern right from wrong, identify spin doctoring, challenge their superiors and blow the whistle. At the least, they would be able to make conscious ethical judgements rather than allow their ethical knowledge and standards be shaped by what they see happening around them in the company. Even if 25% of these students become ambassadors of good BE, we would have made a change, a transformation.
Are the Deans and Legislators listening?

The simplest definition of Business Ethics I have heard

My brother in law is a doctor. We were driving along one day and talking about money, and the ethics of making money. He said "Ramesh, it is not unethical to make a lot of money, as long as you make it the right way".
That for me is the simplest definition ever of Business Ethics. Alas, it is often ignored, or else we would not be in the midst of the largest bail out in history!

Bribery.........and Extortion

Bribery is a red rag to any BE practitioner. But I would like to throw a big red flag at the BE community by adding a new word to the Ethics dictionary - Extortion. I met a businessman a few days back who runs a medium sized firm and asked him if his firm paid bribes. He said "I have a policy of not paying bribes, but I do get extorted from time to time. I have been trying to resist being extorted without success". Now, there is a subtle difference between bribery and extortion. One normally pays a bribe to give legitimacy to an unlawful act, like a pollution clearance for untreated effluents. But extortion is where you are forced to pay a fee for getting permission to carry out a legal business activity. A property developer in Delhi has to pay a "fee" to get legitimate building plans approved, an activist in Manila has to pay a "fee" to get a non-profit registered and I learnt that even in some US cities there is a "fee" for getting licences to start a petrol pump or a restaurant. Large business houses and MNCs have the ability to avoid being extorted or to manage this by engaging lawyers or agents or franchisees to do the not so clean work, but most small businesses have no easy escape routes. Extortion raises a number of interesting questions for the BE community. Firstly, it does not qualify as a payment for routine governmental action, so what would be the status of extortion vis-a-vis FCPA? A small business that resists extortion may soon be out of business, so would we label a small firm as 'unethical' for allowing itslef to be extorted? Can organisations equip themselves not to be extorted, or atleast to reduce the frequency of the experience? I met a German who lives in Hyderabad in India and runs a bio-tech exporting company there. He told me how he has put in place an elaborate mechanism in his company to avoid being coerced. What he told me was fascinating, but that would be another blog. I would'nt like to extort too much of your time at one go!

Are buying decisions influenced by Ethics?

This is my first blog on this complex subject that has fascinated me for the last 8 years. As a teacher of this subject, I continue to learn every time I step out to teach. I share one such experience here. I was lecturing a class of MBA students in Bangalore on the vitures of ethics and how companies with good ethics attract more customers. Up went a hand and a question - "Sir, do you think an Indian buyer would ponder over the ethics of the brand owner when choosing a mobile telephony service, or would he or she go by the price and features?" I had no answer. As I drove home, I searched for an answer, got none and went to sleep. When I woke up I had the answer, which was so simple. Business Ethics in India was at a stage of evolution where it would impact B2B decisions, but not yet B2C. It would take us some years to be where the Developed World is (or we believe the Developed World is), where a fair number of consumers base their decisions on the ethical standards of the brand owner. This should be true of many other developing countries. But reach there we will, and when that happens companies with good reputations would reap the benefits of their virtuosity!