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.