Volkswagen’s diesel emissions cheat has cost the company dearly. Last October, Volkswagen reached a US$16.5 billion dollar settlement with the US government, and the value of Volkswagen’s stock today is worth about 50% of what it was before the scandal – a US$60 billion drop in the company’s valuation. Criminal charges against several senior managers, including chairman Hans Dieter Poetsch, are still pending. Countless customers are furious, while many employees fear for their jobs as Volkswagen scrambles to cut its costs. (Some background on the scandal, as well as a regularly updated timeline, can be found here.)
What started as a “simple cheat” became a slippery slope for the whole company. Volkswagen failed to create a culture of corporate integrity; the institutional checks and balances that are supposed to prevent something like this from happening were purposefully or ignorantly subverted, and the company created all the wrong incentives. As Alison Taylor has argued on this blog, these are the perfect ingredients for a corrupt corporate culture.
Who to blame for this mess (and, similarly, many other corporate messes)? Just as “a fish rots from the head down,” a company’s board of directors must take responsibility for creating or allowing a toxic corporate culture that permits cheating and other unethical and illegal behavior.
Boards are elected by the company’s shareholders to supervise top management and provide strategic input. The board is not responsible for day-to-day management of the company. But one of the board’s key responsibilities is to supervise management by, for example, ensuring that the necessary control systems are in place for risk management, audit, and so forth. In other words, the board is responsible for keeping their eyes on, but their hands out of, the management of the company.
Partly due to new laws, such as the Sarbanes-Oxley Act (SOX) and the Dodd-Frank Act, many boards have evolved from mostly box-ticking gentlemen’s clubs to an ever more professional and integral unit of a company with clear roles and responsibilities. However, much work remains to be done for boards to live up to their responsibilities. One specific dilemma for boards is to manage their time between providing control of past performance and giving strategic guidance. Indeed, too often boards take a backward-looking perspective to control for legal compliance, rather than a forward-looking view. But, as Transparency International and others argue, boards should focus on an improvement on corporate integrity.
Indeed, over the past years, boards (with generous help of consultants) have produced countless codes of ethics, codes of integrity, or codes of conduct. But, despite billions of dollars spent on corporate integrity, breaches of corporate integrity on an ethical and legal level abound around the globe. So far, 33 FCPA enforcement actions have been brought by the DOJ and the SEC in 2016 alone – the fourth highest number ever. What is lacking? What must boards do to fulfill their duty and protect the integrity of their corporations?
Corporate boards should focus on four questions that they need to put to themselves and company management—and they must insist on clear and satisfactory answers if they are to fulfill their responsibility to ensure corporate integrity:
- Do we have the right ethical principals in place that are relevant, easily understood and applicable? Laws and rules may be important, but sometimes detailed rules and restrictions can crowd out principles. No employee wants to read hundreds of pages of ethical behavior guidelines that are not relevant to his or her job, or may apply only once in the employee’s career. Ideally, ethics and integrity guidelines should be easily understandable for all, with additional and more detailed provisions for employees with specific functions (such as sales or government relations). Boards must also ensure that management creates rules and guidelines that are actually applicable to the business, that match the purpose of the company and its incentive systems. For example, a company that over-incentivizes sales in corrupt regions, and punishes employees who don’t succeed in meeting their targets, might confuse its employees, who are likely to find strict ethics guidelines inapplicable when they contradict the incentives (see, again, Alison Taylor’s post on the characteristics of corrupt corporate cultures).
- Do we have the right tools in place to help people understand corporate integrity?
Too often, management believes that online integrity training is sufficient. But ethical behavior is about behavioral norms and principles, which cannot be learned by clicking a box in an online-form. And to the point above on applicability of ethical guidelines to different employee groups: a good company will help its employees understand the specific ethical risks and guidelines relevant to their functions, if necessary through special workshops. Management should not be allowed to cut corners by relying on often too simplistic web-seminars.
- Do we have the right enforcement mechanisms in place? Having the right information and accountability mechanisms in place is crucial. Companies that allow for opacity in who is responsible for specific decisions (e.g. environmental protection, community engagement, hiring practices) create a lot of room for short cuts, inefficiencies, and lack of accountability. Boards must make sure that specific people feel responsible, and are empowered for their (ethical) decision-making. Boards should also make sure that whistleblowing mechanisms are in place (see for example here and here) to report on unethical behavior. In the end, boards must ensure that management sets up fair and transparent means and process to punish unethical behavior and reward those who say no to bribery/unethical behavior – even at the costs of lost revenues in the short-run, as Johann Graf Lambsdorff illustrated in this post.
- Are we living our ethical behavior every day – starting on the board? Ethical behavior of a company is an everyday business and needs to be lived from the top to be credible to the whole company. If the board is not honoring the social contract of ethical behavior (for example, by not being transparent), employees will find it much easier to create a cheating culture for themselves. Furthermore, the board should encourage employees to contribute to the improvement of the corporate integrity standards.
The fight for corporate integrity is an uphill battle that constantly needs reinforcement by the board. Boards must not forget – and must keep pushing everyone in the company not to forget – that ultimately starting down the slippery slope of unethical behavior will be far more costly to the company than is sustained investment in ethical behavior – a lesson that Volkswagen, and many other companies, have learned first-hand, but too late.
Thanks for this post, Christoph! These all seem like good, and reasonable, ideas. I wanted to ask about why this push for corporate responsibility has been lacking up until this point. As you say, “billions of dollars [have been] spent on corporate integrity” and so I am wondering what kind of programs have been developed up until this point and why you think they are so insufficient. Does this suggest that there is already a strong commitment to promoting ethical corporate behavior, but that commitment has just been poorly organized and structured? Or is there perhaps a more invidious answer: that corporations are willing to spend money to give the appearance that corporate integrity is an important goal, but, when it comes down to it, that’s really just window dressing because they figure that the benefits are greater than the risks for less-than-ethical but profitable behavior?
Good points Clara. I was also wondering how companies manage to spend so much money on consultants. Is it because these are mostly outside people with no longterm relationship or understanding of the corporation? Or is it because a particular manager feels the need to show somebody else (perhaps even a member of the board) that “hey, we take this seriously, look how much money we spend on it”, but that manager is less concerned with the substance of the ethics reports?
As for Clara’s second point, don’t the SEC and the DOJ consider the extent to which a company has “attempted to comply” with FCPA laws when evaluating how much to fine that company? If they use the amount of money the company has spent as a metric of that attempted compliance, then that may create an incentive for the company to pay for ethics consultants but might not create enough incentive to make the necessary structural changes.
Thank you for the post, Christoph! Similar to Clara’s thoughts, I also wondered what specific steps companies have actually taken with this increased spending on corporate integrity. I am not sure if you are suggesting that companies have thus far been taking the wrong approach with this spending, or rather if they are going in the right direction and just need to go further (or, as Clara suggests, if the spending is merely a facade). It is surprising to me that these expensive consultants would not suggest many of the strategies you highlight in your post, so perhaps the problem is more that the Board is unwilling to make these changes, rather than not understanding what types of changes would be effective. If that is the case, the question then becomes how can corporate boards be incentivized to promote corporate integrity? It seems that FCPA enforcements have not been enough based on the statistic you cite. I would be interested to hear other strategies for incentivizing boards to take corporate integrity seriously that you have come across.
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Thank you for your comments and questions. I wish there were easy answers.
Clara: many boards and companies take the responsibility of corporate integrity indeed seriously and have spent a lot of effort and time developing standards both for their own conduct and – often enough – for their suppliers as well. Companies also spend a lot of effort and money on training employees about codes of conduct – albeit, in my opinion, too often only through online trainings.
Two issues, however, are often difficult: first, are companies creating these programs mostly to show their willingness and interest in fighting corruption/increasing integrity – to Michael’s point of FCPA creating incentives to have a program – or are they doing it to indeed change the behavior. A behavioral change requires a lot more than codes of conduct and trainings – it might require an overhaul of the incentive structure, decision making structure, control structure,…
The second issue is whether a company is really willing to risk business and revenues for ethical considerations. Codes of conduct often go well beyond legal compliance, which creates dilemmas for boards. Should a board, for example, fire a very successful CEO if s/he starts a relationship within the company with an employee who does not report to her/him – if the code of conduct prohibits romantic relationships within the company? If they don’t fire him/her, the slope becomes slippery – and if they fire him/her, they might face issues with the shareholders who see their share price drop.
And Carina, many a company is doing a fair job in becoming more compliant – with and without consultants. However, especially MNCs face serious complexity in this matter due to a) multiple businesses, b) multiple jurisdictions and c) multiple cultures – making compliance and ethical behavior contingent and evolving.
I want to stress that the article does not suggest a one-size-fits-all approach. Rather, the board needs to make sure that the compliance/ethics program fits the specific circumstances, culture and strategy of each company – which makes the role of the board all but rubberstamp.
I wish I had seen this before I posted – seems like we were writing at the same time. Your response did spark one thought: Given that there are some companies out there that do take corporate integrity very seriously, what do you think are the main motivators for those driving the agenda a those companies? Is it to lower long-term costs? To avoid bad PR? Better for business? Personal ethics? Maybe looking into the reasons why board members at the ‘best’ companies on corporate integrity spend time and money on this issue could also provide insights into how to effectively motivate other boards? Complicated and interesting stuff Christoph. A great topic.
Christoph, I think this is a really important post to try and shed light on meaningful ways that corporations can reduce the “supply” of corruption through more effective board oversight. That said, I was left with a similar set of questions as Carina (building on Clara’s and Mike’s points). I’m somewhat skeptical that the reputational and/or legal costs of compliance are sufficient to incentivize a board to really dig in and try to change an institutional culture for three reasons: (1) compliance can become just a “cost of doing business” that functions as “window dressing” (as Clara noted above) for practices that are actually profitable, (2) the expenditures on compliance become a proxy for doing something (as Mike noted) without having another metric to judge “success”, and (3) boards are not sufficiently incentivized to address these issues because shareholders don’t reward “anti-corruption compliance efforts” or punish board members who fail to enact these policies. As to #3, fiduciary duty law might be a useful tool to properly incentivize board action. American corporate law (primarily Delaware state law) imposes a set of fiduciary obligations on board members that will in some cases hold them personally liable for failing to supervise or looking the other way when confronted with serious corporate issues. Developing or strengthening a fiduciary duty to prevent corporate corruption (through the legislature or judiciary) could create the high level of personal accountability required to motivate real reform driven by board members.