CORPORATE FINANCE INSIDER

Creating and shaping an ethical culture

“Tone at the top” is a phrase thrown around plenty in business circles, but setting the proper standards on ethical behavior can make a difference financially and culturally for organizations.
By Janet Hankins and Jacob Blass

Leadership in many types of organizations sometimes fails to distinguish between governance and ethics.

Governance might affect ethics. But this is not always the case. Strongly worded statements and a check-the-box mentality do not guarantee ethical behavior by organizations.

Forty-one percent of all companies experience fraud at any given time, according to the 2013 National Business Ethics Survey (NBES). And in a survey by the Chartered Institute of Management Accountants, 30% of respondents in the United Kingdom report feeling under pressure from managers or colleagues to compromise their organization’s ethical standards.

Additionally, a 2014 survey by the Association of Certified Fraud Examiners (ACFE) showed that:

  • The median fraud incident was $145,000;
  • 22% of fraud incidents were in excess of $1 million; and
  • A typical company loses 5% of its revenue to fraud.

But fraud isn’t the only ethical concern affecting organizations. Other critical financial and reputational risk factors include:

  • Regulatory issues.
  • Lying and falsification of records.
  • Ineffective service.
  • Harassment.
  • Drug and alcohol abuse.
  • Discrimination.
  • Wrongful termination.

The book Ethics 101 by John C. Maxwell cited a workplace survey indicating that 43% of employees admitted to recent unethical acts in the workplace, and 75% observed unethical acts and did nothing about it. Here are four reasons workers didn’t say anything:

  • They are part of the 43%.
  • They don’t care.
  • They don’t feel safe reporting a fraud incident.
  • Why bother? Nothing will be done anyway.

Leaders who don’t elevate culture to an essential priority risk long-term business and reputational problems, as NBES research shows that ethical culture is the single biggest factor determining the amount of misconduct that occurs in a work environment.

This reinforces the importance of a proper ethical tone from leadership, and then carried out by management, in protecting an organization against malfeasance—addressing those cases having the greatest potential to cripple the organization’s finances and reputation.

The financial case for ethical standards

Ethisphere, a research organization, has distributed a list of the World’s Most Ethical Companies (WMECs) since 2007. The companies that make regular appearances on the list not only make ethics a part of their organizational culture but also perform better financially than a peer index of companies.

WMECs tend to have:

  • More diverse boards and more independent directors.
  • More frequent and robust communication with employees.
  • More frequent assessments of culture and a greater likelihood of annual evaluation of their compliance and ethics programs.
  • A wider variety of topics in culture assessments, including items related to reporting misconduct.
  • Stronger policies against retaliation, protecting those who report misconduct.

Companies that strongly emphasize an ethical culture are marked by several actions, according to Ethisphere, including:

  • Increasing the amount of incentive programs for employees who engage in, or actively support, ethical conduct.
  • Greater visibility of the compliance function, which will also have greater involvement in business decisions.
  • More resources for middle managers to promote compliance and ethics in their departments.  For example, 67% of WMECs provide intranet resources on compliance and ethics specifically for managers, compared with 48% of other companies.
  • More sharing of compliance and ethics information with boards.

Companies, even ones already classified as ethical, are doing a better job implementing ethics as a strategy, instead of managing by incident. In 2013, 72% of WMECs had developed a communications plan to articulate company-wide compliance and ethics messages. In 2015, 94% of WMECs had such a strategy in place. They also review their programs more frequently than peers, which enables them to update policies and training programs and create benchmarks.

Companies that have a chief compliance officer (CCO) are increasing the visibility and focus of the compliance role. That person regularly communicates with the company’s board on compliance and ethics initiatives at the company.

WMECs assess compliance and ethics risks more frequently than other companies, more often using strategies such as employee interviews or surveys, management interviews or focus groups, and external documentation review.

They also do a better job evaluating a wider variety of risks, which results in more robust risk management. For example, 95% of companies on the 2015 Ethisphere list include reputational risk as part of compliance and ethics assessment.

Warren Buffett, in testimony before a Congressional subcommittee in 1991, said: “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”

Organizations must go beyond making statements about doing business ethically, moving beyond words to action. Establishing ethical culture requires a commitment to doing more than checking boxes for compliance. Only then will stakeholders know that they should make an equal commitment to ethical practice, increasing ethical outcomes and reducing malfeasance.

Janet Hankins is founder and CEO of Ethical Advocate, and Jacob Blass is president of Ethical Advocate, a provider of governance, risk, and compliance services such as ethics hotlines and training.

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