Ethics Class

James McRitchie developed the following background/issues on corporate ethics exclusively for Norwich University’s MBA program. In this instance, he monitored and advised students largely by posting to discussion boards on the internet. He is available for similar projects with your university or corporation. Contact jm@corpgov.net.

Corporate Ethics

The year 2002 was a banner year for those who believe that corporate ethics is an oxymoron. Arthur Andersen was convicted of obstructing justice. Merrill Lynch settled a lawsuit that alleged it misled investors. Enron, Global Crossing, WorldCom and others tumbled into bankruptcy. Profiles of many business leaders read like a crime blotter.

Prior to the bubble bursting, corporations enjoyed unprecedented access to capital. For example, there were 2,800 stock offerings from 1995 to 1999. By January 2000, more than 84 million Americans owned stock. That’s double the number of just 17 years earlier.

CEOs were well paid for their efforts. Their pay went from 42 times the average worker’s pay in 1980, to 85 in 1990, and then skyrocketed to 531 times by 2000. (In contrast, Japanese executives still earn only 20-30 times the lowest paid worker, while in Europe the ratio is about 40 times.)

Many Americans are fed up with what they see as a breakdown in ethics and accountability. A recent BusinessWeek Harris Poll found that 79% believe CEOs put their own interests ahead of workers and shareholders.

Confidence in the market has reached lows not seen since the 1930s. Yet, our economic strength depends on the willingness of individuals and institutions to see shareholding as a prudent investment. How will investor confidence be restored? “The secret of success is honesty and fair dealing,” Mark Twain, once said. “If you can fake these, you’ve got it made.”

Apparently, that strategy worked at Enron. For three years, Enron was named one of the 100 Best Companies to Work for in America. In 2000 Enron received six environmental awards. It had progressive policies on climate change, human rights, and anti-corruption. Its CEO gave speeches at ethics conferences and put together a statement of values emphasizing “communication, respect, and integrity.” The company’s stock was a favorite among “socially responsible” mutual funds.

After Enron’s fall, one of the hotter items on e-Bay was a 64-page paperback, the Enron corporate code of ethics. “Never been opened,” proclaimed one seller, a former employee. Do the problems on Wall Street stem from a few rogue executives or is the entire system flawed?

According to Justice Department data, U.S. Attorneys prosecuted only 187 defendants over the last decade for white-collar crimes. While 142 were found guilty — a healthy 76% conviction rate — only 87 did time, usually at minimum security, “country club,” prisons.

According to a recent Investor Confidence Tracking Study, conducted by Rating Research LLC, only nine percent of individual investors are “very confident” in the financial information provided by publicly traded companies. The Sarbanes-Oxley Act of 2002 dramatically increased the penalties for corporate and financial fraud. Will stiffer penalties do the trick or are other reforms needed?

During times of great social change, such as ours, all social institutions, especially businesses, face increasing questions concerning their legitimacy. Every significant profession and most institutions that engage in at least minimal self-reflection, proclaim some sort of ethical standards. A call for new standards of ethical behavior for our corporate leaders echoes through boardrooms, congressional hearings and union halls. Whose standards and what reforms should be adopted?

The following questions will help you think about some of the issues:

1. Should election of corporate directors be more democratic?

Directors appoint the CEO, set management’s compensation, approve long-term goals and evaluate performance. Yet, historically, directors have often been selected or screened by management, paid by management and informed by management. A 1991 survey by Korn/Ferry found that most board vacancies were filled via recommendations from the CEO. We speak of directors as “representing” or being “elected” by shareholders but shareholders typically play no role in their nomination. Is that evidence of a challenge to good corporate governance or are such practices necessary so that boards and management will run smoothly and effectively?

2. Does nondisclosure of proxy votes by institutional investors violate the interests of shareholders/beneficiaries?

The Department of Labor has long held that, since proxy voting can add value, voting rights are subject to the same fiduciary standards as other plan assets and must be voted in the best interest of plan beneficiaries. The same standards of trust law also hold for mutual funds, as clarified by former SEC Chair Harvey Pitt. Are the true owners better served by disclosing the votes of institutional investors or are there important reasons for keeping such votes confidential?

  • SEC proposal Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies: Release Number 33-8131. See comments.

3. Investors should take a company’s performance on social responsibility into consideration when making investment decisions.

Companies with bad reputations can be punished, both internally (through staff morale and recruitment) and externally (reputation and share price). In a recent survey of 20,000 people in 20 countries, 25% of US respondents said they had bought or sold shares on the basis of a company’s social performance. A similar picture emerged in Canada, Japan, Britain and Italy. In a world in which reputation is an increasing part of corporate value, how important is social responsibility?

4. Whistleblowing can be an effective way of reducing the number of unethical decisions made by management.

Time Magazine named Coleen Rowley, Cynthia Cooper, and Sherron Watkins Person of the Year “for believing – really believing – that the truth is one thing that must not be moved off the books, and for stepping in to make sure that it wasn’t.” Rowley wrote a letter to FBI Director Robert Mueller criticizing the agency for ignoring evidence before September 11th. Cooper alerted WorldCom’s board in June to $3.8 billion in accounting irregularities. Watkins sent memos in August 2001 warning Enron chairman Kenneth Lay that improper accounting could cause the company to collapse. Are whistleblowers effective guardians of corporate ethics?

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