The ethical dilemma of corrupt practices and good governance

•  Can corporates draw the fine line?

I am certain that most of youhave heard of the Enron scandal which led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, and the dissolution, in 2002, of Arthur Andersen, one of the five largest audit and accountancy partnerships in the world. Enron, through the use of accounting loopholes and poor financial reporting, hid billions of dollars in debt from failed deals and projects. It became the first non-financial company to use the mark-to-market accounting method to account for its complex long-term contracts. As you all know, mark-to-market accounting requires that once a long-term contract is signed, income is estimated as the present value of net future cash flow. Often, the viability of such contracts and their related costs are difficult to estimate and investors are given false or misleading reports. Enron also used off-balance-sheet entities to artificially inflate profits to make the Company look financially secure when it was not.   Enron fall How and why did Enron – which was voted as having one of the best Boards and as one of the best companies to work for in America – derail? Even with complex corporate governance mechanisms and checks and balances in place, Enron was able to “attract large sums of capital to fund a questionable business model, conceal its true performance through a series of accounting and financing manoeuvres, and hype its stock to unsustainable levels.” It derailed because it lacked an ethical compass that propelled corporate governance and business practices in the right direction. Former CFO of Enron Andy Fastow evidences this when stating that “Accounting rules, securities laws and regulations are vague. They’re complex … What I did at Enron and what we tended to do as a company was to view that complexity, that vagueness…not as a problem, but as an opportunity. The only question was do the rules allow it — or do the rules allow an interpretation that will allow it?” Fastow later testified that he “knew it was wrong…knew it was misleading” but neither he nor his senior colleagues acted on the truth, leading to corrupt governance of the highest order.They failed to draw the line! But what is this line? Almost all of Enron’s projects and deals were approved by auditors, lawyers and even by government bodies. Were they really doing something illegal? The simple answer is NO. Companies, after all, like human beings do not exercise consistent moral behaviour. But with growing transparency and accountability in a globalised economy, corporate organisations not only need to acquire a sound business sense in the competitive marketplace but a constant reflection of ‘are we doing the RIGHT thing?’ To an ethical business organisation, ethics is not merely about adherence and compliance to a set of regulations. Nor is it about trying to bend the rules without breaking them. It is about doing business RIGHT. This is where Enron failed miserably.   Businessand ethics Often business and ethics are viewed as two separate worlds. Yet a sustainable business is defined by the ability of companies to do repeat transactions with their customers. Customers need to feel that they are treated fairly and honestly. In places where institutions are weak, ethics plays a fundamental role in facilitating repeat business transactions and, as such, driving a sustainable private sector. Ethics is no longer languishing in the periphery of the corporate structure. Instead, it often acts as the conscience of the legal person or corporate, providing it a moral core. Without a culture of good governance rooted in progressive business ethics, the ‘right thing’ simply does not get done. Today’s landmark documents of business ethical behavior – be it the OECD Anti-Bribery Convention, the UN Convention against Corruption or the UN Global Compact – reflect the importance of ethics in conducting business and preventing corruption. Good corporate governance is increasingly emerging not only as a tool that increases efficiency, improves access to capital, and ensures sustainability — it is also emerging as an effective anti-corruption tool. Simply put, on the day to day transaction level it makes bribes harder to give and harder to conceal. At the decision-making level, it injects transparency and accountability, so that it is very clear how executive decisions are made and why.   Olympus scandal Let us revisit the Olympus scandal of 2011, when “one of the biggest and longest-running loss-hiding arrangements in Japanese corporate history”, according to the Wall Street Journal, was exposed. The matter quickly snowballed into a corporate corruption scandal over concealment of more than 117.7 billion Yen ($1.5 billion) of investment losses and other dubious fees and payments dating back to the late 1980s. By 2012 the scandal had wiped 75–80% off the company’s stock market valuation, led to the resignation of much of the Board and raised considerable concern over Japan’s prevailing corporate governance and transparency. It even shamed the Japanese financial markets globally. Interestingly, The Economist said that the Olympus scandal “is not an accounting misdeed—it is a mindset… it is about the malleability of rules, and the subjectivity of their enforcement. Until Japan’s institutions of governance—those internal to the corporations, as well external regulators and prosecutors—change, Japan cannot change.” Similarly, we in Sri Lanka – withthe dawn of a new political era – needa culture of good corporate governance to erase the ‘dilemma’ once in for all. Only a radical shift or change in mindset will translate to a progressive change in business practice, which in turn will establish and cement a culture of good corporate governance.   Corruption I firmly believe that without such a change corruption can never be uprooted. Corruption has many faces and many moving parts. In some instances business can be a source of corruption, in others it is simply a victim. Corruption is a corrosive drain on public trust and on the legitimacy of public and private sector institutions. Its toll can be devastating to a national economy. Corruption affects all types and sizes of business firms — from global conglomerates to Small and Medium-Sized Enterprises and co-operatives. It has the power to destroy firms and with them the livelihoods of stakeholders who depend on a company’s success. This further dehumanises and undermines the reputation of the private sector as a positive force for economic growth and development, especially in developing countries. For in reality, predictable, competitive, and fair economic environments free of corruption are central to sustainable business, economic growth and national development. After all, the private sector can be a force in developing solutions to the corruption problem, and companies around the world are currently taking charge. They are doing it in multiple ways. Some companies make their business environment more transparent. Others push for ethical standards and fair practices in dealing with the government. However, they all believe in an expanding culture of ethically founded business practices.   The Tyco scandal The Tyco scandal offers some major lessons to the business world on the substance of good corporate governance. But it also stresses on the necessity of a key factor, without which the essence of my presentation cannot be fully understood. Without a strong – and at times even courageous leadership – aculture of good governance or a progressive system of ethics cannot exist; nor can the mindset of the corporate body be geared towards acting on the ‘right’ instead of the ‘wrong’. The Corporate Leader paves the way to make this possible and today even the UN Global Compact recognises this. The fundamental component underlying much of what the best ethical companies do is leadership. Leadership, made visible through actions, commitment, and examples, sets the moral tone that emanates from the top of a company, and that in turn, translates ethical principles into the concrete behavior expected from all persons acting on behalf of a company. In 2002, Tyco’s CEO and CFO were arrested and charged with misappropriating more than $170 million from the company. They were also accused of stealing more than $430 million through fraudulent sales of Tyco stock and concealing the information from shareholders. To restore investors’ faith, Tyco’s new management team reorganised the company and recovered some of the funds that were misappropriated. At its annual meeting, shareholders elected a new board of directors, voted to make future executive severance agreements subject to shareholder approval, and also voted that the Board Chair be an independent person rather than a Tyco CEO. The company also hired Eric Pillmore as Vice President of Corporate Governance. Pillmore was determined to revamp Tyco’s ethical culture. Under his leadership, Tyco implemented a corporate ethics program and replaced 90% of the headquarters staff. The company also created the Tyco Guide to Ethical Conduct. Pillmore worked to incorporate three elements into Tyco’s culture: 1) strong and ethical corporate leadership; 2) accountability; and 3) behavior tracking processes. He also created an ombudsman position at Tyco who can mediate between employees and management. It was outstanding that within a few years of being scandalised Tyco won the award for “Outstanding Improvement in Board Governance.” Although Eric Pillmore departed from Tyco in 2007, he won the honour of being one of the “100 Most Influential People in Business Ethics”. Since the scandal, Tyco has been periodically reviewing employees and business operations to identify areas of weakness. After one cultural diagnostic survey revealed that ethics and compliance was taken more seriously by top managers than the average employee, Tyco’s compliance team implemented additional ethics talks for employees. The company continues to restore a reputation for ethical conduct. In 2010 Tyco joined the World Economic Forum Partnering Against Corruption Initiative to combat bribery. The company’s successful comeback is primarily attributed to strong and courageous leaders, who surmounted adversity by focusing on a long-term financial plans centred on a ground-breaking ethical business model. In this model there is no dilemma...no drawing of lines. The corporate is now a conscientious citizen driven not by executive greed and let’s-get-it-done business pragmatism but by the strong sense of doing the right thing.   Corruption is the enemy of development PrathibaPatil the 12th President of India once stated that, “corruption is the enemy of development”…be it in the corporate or the political world; in the private or the public domain. Only good governance in all spheres of life can help activate progressive ways of living and conducting business. One of the key lessons I learnt from a Bernie Maddoff is that no personal gain is worth risking the corporate brand and image for…and that in the long term, the paltry sand castle of corruption can never compare to the lofty, luminous arches of good corporate governance. (The writer, FCA, is Chairman – Lanka Rating Agency, Deputy Chairman – Commercial Bank of Ceylon PLC, Group Director – CIC Holdings PLC, Director – John Keells Foods PLC, Director – EAP Holdings PLC and Deputy Chairman – Sri Lanka Institute of Directors.)