24 April 2019 by Indira Ramkissoon-Rambharose
An extract from the runner-up for the Tom Morrison Essay Prize 2018
Tom Morrison Essay Prize
The competition was launched in 2016 in memory of Tom Morrison FCIS – an active member and past president of ICSA and a highly regarded and influential member of the share registration industry – and encourages new thinking and recognises original approaches to governance. Now in its third year, this year’s competition sought essay submissions that demonstrated an original perspective on the following topic:
‘It has been said that governance failures usually happen within the subsidiary structure of a large business, but all governance focus tends to be at the main board level. Is the focus on the right area and, if not, what improvements could be made?’
Tom Morrison Essay Prize
This is an extract.
Just days ago, 135 companies from 23 countries spanning 57 industries were honoured for making the list of World’s Most Ethical Companies according to the Ethisphere Institute.1 These businesses accounted for approximately US$5.16 trillion in market capital, US$2.08 trillion in annual revenues and touched 6.28 million employees across the globe2 and highlight that critical to ensuring governance success is having and complying with the rules of ethical conduct.
Regardless of country, industry or scale of business, this essay will argue that governance failures – be it within the subsidiary structure of a large business or at the parent company – are a direct result of the lack of an effective ethical framework pervading business operations.
This essay will illustrate that what occurs below board level and within the subsidiaries3 are equally important as what happens at board level. An ethical framework constitutes the epicentre of successful business governance, as it goes beyond the gaps left by legal provisions, which only ethics can fill.
Businesses can no longer underestimate the reputational and financial risks that subsidiaries bring4 as they ultimately have responsibility for financial losses and suffer reputational damage from governance failures at subsidiaries. Bhopal was a tragic wake-up call to companies to pay more attention to subsidiaries5 and not only to pay attention after a scandal or failure. Barings Bank collapsed due to the unethical behaviour at its Singapore subsidiary.6
The BP Deepwater disaster and the News Corporation phone hacking scandal, both occurred in group entities with their own boards.7 With businesses growing apace on all fronts – global, regional and local, having a robust ethical framework in place is more essential than ever.
Businesses are under pressure to remain profitable and to show a good return to shareholders. Often this can result in unethical decisions being made. Ethics makes no concessions for the real or imagined necessities of making a profit.8 One of the basic principles of ethical behaviour in business is having genuine books of accounts prepared.9
The failure of Enron was not due to an ‘audit failure’ as advanced, instead it seems more accurate to state that it was an ‘ethics failure’ of immense proportion. Enron chose to inflate earnings and hide debts in special purpose vehicles where the culture allowed secrecy, rule-breaking and fraud. Enron’s downfall and the imprisonment of the CEO is one of the most widely reported ethics violations of all time. Ethics must begin at the top, it is a leadership issue and the CEO must set the example.10
How ironic indeed, that Enron was named as ‘America’s Most Innovative Company’ by Fortune Magazine for six years in a row prior to the scandal.
In similar vein, the CEO of WorldCom made outright fraudulent accounting entries until the fraud was discovered. The bankruptcy examiner’s report on the collapse of Lehman Brothers found credible evidence that the CEO, who was later convicted, had approved misleading statements and used accounting gimmicks to hide the truth.
While some postulate that these executives suffered from Hubris Syndrome,11 it seems more apt to conclude that they suffered from Unethical Syndrome.
Corporate governance failures are not confined to any country, industry or sector. In 2017, for the fifth year in a row, the finance, retail and technology sectors continue to register the highest number of ethical lapses according to IBE.12
These lapses can also be seen in banking, general retailers, technology, the gig economy,13 leisure and travel, mining and extractive, food and beverage, support and professional services, automobiles and parts, aerospace and defence as well as consumer goods.14
In the USA, at Tyco there was looting by the CEO and CFO with improper share deals; at Global Crossing there were inflated corporate profits to defraud investors; and at Xerox there were dishonest accelerated revenue recognition.
The collapse of Wall Street demonstrated the importance of ethics, as once highly esteemed financial institutions made headlines for bad choices and questionable behaviour. At Satyam, aka India’s Enron, there were malpractices and fraud by the CEO over several years. In Netherlands, at Royal Ahold, earnings were overstated, while at Parmalat in Italy, false transactions were recorded.15 These demonstrate a lack of ethics at the very highest level. A properly enforced ethics framework could have averted these failures and scandals.
The governance of businesses includes ethical responsibilities. The principles of business ethics for governance success of subsidiaries and parent companies alike must include: integration, whereby ethics must penetrate all aspects of the business and be reflected in governance systems; promotion of workers, where ethical principles should guide incentive programmes; internationalization, whereby the business must be clear on its definition of ethics and must ensure that it transcends national borders, thereby resulting in an ethics base that is not limited culturally but which can be applied in a global context.16
Operating without ethics will not only attract huge fines, depending on the offence, but it will also attract significant costs regarding legal fees, remediation work, and lost opportunities. It is certainly less costly to run an ethical business than to engage in unethical practices…
[Condensed for publication – full references available with the full essay online]