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A worrying disconnect

15 May 2017 by Peter Montagnon

Ethics: A worrying disconnect - read more

Failure to follow through on reported ethical values with actual behaviour is destructive

The question of corporate culture has shot up the boardroom agenda over the past couple of years. As they reflect on a seemingly endless series of scandals, directors are asking themselves what they can do to shape behaviour within their organisations to minimise reputation and conduct risk.

Yet although the debate is itself a healthy sign, there is evidence many companies have a long way to go to resolve the underlying issues. This is borne out by the Institute of Business Ethics’ (IBE) recent annual survey ‘Ethical Concerns and Lapses 2016’, which is based on extensive reviews of press reporting about companies and how they are behaving.

The latest report found 604 press stories about ethical concerns and lapses in 2016, compared with only 376 stories in 2015. Most of them referred to large companies, with 18 out of the 20 most frequently mentioned being publicly-listed, and nine being FTSE 100 companies.

Not the whole story

Admittedly, one must take these figures with a pinch of salt. The mere fact that more stories are being written does not necessarily imply the lapses are more serious. Similarly, it is unsurprising the press focuses its attention on larger companies. They are, after all, more newsworthy, but this does not mean they are worse in their behaviour than smaller companies, whose lapses may simply go unnoticed.

On the other hand, according to the IBE’s statistics, 95% of the top 20 miscreants have a defined set of values and 85% have a publicly available code of ethics. The disconnect becomes even clearer in Grant Thornton’s annual review ‘The Future of Governance’, which shows that while 86% of FTSE 350 companies mention corporate culture in their annual report, 48% do not clearly communicate their organisation’s values. Companies know what they want, but many are not yet very accomplished in making it happen.

“Boards need to decide how best to position themselves to address the issues of culture and behaviour”

There is clearly a task for governance here, and one which has been picked up by the Prime Minister and reflected in the Government’s Green Paper examining the need for board reform.

Boards need to decide how best to position themselves to address the issues of culture and behaviour, and they need to decide how they should divide up the task with the executive if they want to avoid micromanagement. These issues should be an important theme of the review of the UK Corporate Governance Code, due to be undertaken by the FRC later in the year.

Lack of follow through

One weakness the IBE has identified is the failure of many boards and management to follow through on the establishment and promulgation of company values and codes of behaviour.

Too often directors feel that all they have to do is sign-off on values and a code and the rest will follow. Yet codes have to be embedded, which requires a communication and training effort. The culture has to be supported – tone from the top really does matter.

Finally, there needs to be some systematic approach to monitoring to provide the assurance that the culture is the one the board actually wants.

For many boards, anxious to get on with the business of building the company and taking it forward, this is all too boring and too much effort. Yet, ask companies that have suffered a shock – be it misstatement of accounts, fraud, exposure of unacceptable labour practices or environmental damage – and they may well express regret at not having taken the issue of culture and behaviour more seriously.

Severe consequences

The damage is not just reputational, but financial and operational. Think of the total cost to Volkswagen, which has already incurred fines and customer settlement costs of $24.5 billion in the US alone, as a result of its emissions cheating or the £671 million fine paid by Rolls-Royce as a result of its admission of bribery.

“The damage is not just reputational, but financial and operational”

Think of companies like BP, Standard Chartered or Alstom in France, which have all had to pay for the intrusion of US-appointed monitors to oversee their businesses. Think of the number of chief executives who have had to resign in disgrace after scandal hit them. Even for those who do not want to get too bogged down in ethics, there is a powerful rationale for getting to grips with the issues of culture and behaviour. It falls naturally into risk management. The challenge is to find a way of doing this systematically, without getting so involved that managing the culture becomes more important than managing the business for success.

Designated committee

The IBE has concluded it is sensible for companies, especially larger ones, to consider having a board committee to monitor culture and behaviour issues, as well as the company’s impact on society. Last year it conducted research in collaboration with ICSA which showed that 57 companies out of the FTSE 350 already have such a committee, even though it is not a current requirement of the UK Corporate Governance Code.

For some of these companies, notably those in the banking sector, an important motivation is that the audit committee is already seriously overloaded with financial risks and unable to take on non-financial risk as well. For others, like those in the mining sector, the non-financial risks around issues like health and safety and the environment are simply too large to be subsumed into the audit committee’s work.

The merit of appointing a committee to undertake this task is that its terms of reference and resourcing should ensure that the relevant issues are systematically covered. Committees are required to report to the board on a regular basis and this means the full board will pick up on the serious issues that arise, without having to waste its time on generalities or micro-reporting.

Overseen code of ethics

Similarly, the IBE has proposed that the Corporate Governance Code should encourage companies to develop a code of ethics, which is overseen and monitored by the board. Our data shows that around three-quarters of FTSE 100 companies already have such a code. What needs developing, however, are techniques for monitoring, oversight and accountability.

“The Corporate Governance Code should encourage companies to develop a code of ethics, which is overseen and monitored by the board”

All these issues are likely to come into sharper focus as the debate on the Green Paper continues. Many of the responses, including that of the IBE, homed in on section 172 of the Companies Act 2006. This requires directors to take account of a series of issues when making decisions, including the impact on employees, customers, suppliers, the community and the environment. Importantly, the law also states that directors should be mindful of the desirability of ensuring the company maintains a reputation for high standards of business conduct.

Most commentators now assume that, even if the Government decides not to reword the legislation, it will find ways of ensuring directors pay more attention to section 172 in future. If this is the case, it will almost certainly be insufficient to point to the existence of a set of values and a company code as evidence that the board has taken account of section 172 in the way it conducts its affairs. Boards will need to show they are addressing the risk of disconnect that can arise without proper follow through.

Guilty sectors

At this point it is worth noting that the IBE data on reported ethical lapses shows a heavy focus on particular sectors with banking and finance

(156 mentions), retail (75 mentions) and technology companies (53 mentions) getting much more attention than other sectors. This does not mean the others can relax. Pharmaceutical companies – which did not make it into the top 10 this year – have in the past been hauled over the coals for overcharging developing countries for vital medicines and for bribery in countries like China.

Nor are the issues that command attention static. According to a separate survey by the IBE of public attitudes to business ethics, three concerns have dominated the public mind over the past three years: corporate tax avoidance, executive remuneration, and exploitative labour. However, the survey showed other issues coming up the track, notably data protection and work-life balance. As public attention focuses on these issues, other sectors could find themselves under the press microscope.

Unlisted companies at risk

Finally, small businesses and unlisted business should not imagine they will escape unscathed. We have already seen how seriously Sir Philip Green’s reputation has suffered as a result of the BHS pension scandal. BHS was not a listed company, but its social impact was significant.

Equally, all businesses, including smaller ones, have some reputation to lose and section 172 applies to all directors, whether they are on the board of a big or small company and whether it is listed or not. It is just as important for them that the governance focus includes the way in which the company seeks to set standards of behaviour for its employees.

All that said, it would be highly unfair to conclude that press focus gives a complete picture. For all the 604 reports of bad behaviour, there will have been many instances of good behaviour by companies which have gone unreported because they are not newsworthy. The best companies are adapting their governance and learning to get on top of the issues.

Nothing destroys trust in the corporate world more than a company that claims to be ethical but turns out to have low standards or fails to deal decisively with lapses when they occur. This is why the disconnect between values and behaviour remains dangerous and something of which all directors should be aware.

Peter Montagnon is Associate Director at the Institute of Business Ethics

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