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.