There is no doubt that corporate culture plays an important part in determining whether or not a company is likely to be involved in a corporate scandal. Now, more than ever, directors and CEOs of public companies want to understand and shape their corporate culture. In a prior article, “Fraud’s Red Flags,” I identified and discussed some warning signs of a corporate culture that is likely to breed trouble. This article addresses signs that the corporate culture has ethics and integrity as high priorities.
1. Truth
This is a powerful principle. It has been stated simply as, “Say what you do, and do what you say.”
Michael Ross
When searching for solutions to problems, there are often several alternatives. Directors and senior management often engage in cost-benefit or risk-reward analysis, and sometimes obtain expert opinions. This is certainly appropriate, but in some instances, decisions can be reached, or at least some alternatives eliminated, by simply sticking to the facts. When an alternative has the “benefit of being true,” it is likely to be a viable one.
Decisions based on the assumption, or hope, that “no one will know” are very likely to turn out badly. This is probably truer now than historically was the case because there are so many parties interested in finding the truth for their own purposes. It is not just the press, the various levels of Federal, state and local government and the class action bar. There are also shareholder activists, special interest groups, whistle-blowers and bloggers. They are all out to “scoop” the company with some evidence of the truth that has not been told by the company.
Illustrations of the importance of truth come from many of the investigations of wrongdoing by corporate executives. These investigations often turn from the underlying allegations of substantive violations of law to allegations of obstruction of justice, commonly making false statements to government officials or destruction of documents. How different might the result have been if Martha Stewart had been motivated by truth as a guiding principle during the investigation of her alleged insider-trading.
Truth promotes long-term credibility and inspires confidence among the company’s constituencies. A company’s reputation for truthfulness can facilitate dealings with regulators, help manage investigations into alleged wrongdoing and get the company’s story effectively communicated to the public. We know how we feel about companies whose explanations do not make sense or contradict prior explanations, and it is not good.
2. Disclosure
A general inclination toward disclosure can be a sign of a healthy corporate culture. If the issue is whether or not to disclose material unfavorable facts, stretching to rationalize non-disclosure can be dangerous. A good general indicator of integrity is management’s willingness to disclose material adverse facts. Disappointing financial results or other adverse developments are bad enough, but the failure to make required disclosures compounds the problems. Material misstatements and omissions will cause the company to bear the costs of investigations and litigation, and possibly fines, damages and the loss of credibility with investors and the public.
The disclosure question arises in many contexts, e.g., public company reports and releases to investors, regulatory filings, certifications to creditors, advertisements and promotions and product labeling. Senior management’s propensity to engage in effective disclosure and resist burying salient facts in fine print or behind puffery is an indication of integrity.
There are, however, exceptions to the benefits of disclosure. Competition requires keeping secrets. Strategies for reducing the pressures from Wall Street for short-term profits may include limiting or eliminating disclosure of projections and “guidance.” Shareholder activists tout “transparency” as a bell-weather of good corporate governance, but there are limits. For example, when pressures for disclosure become a de-facto requirement that a company post its code of business conduct on its web site, the benefits of “transparency” may be outweighed by the costs. The incentives to create and take competitive advantage of a confidential, superior code are lost; many companies merely look to see what is prevalent in the industry, and there is a tendency for the substance of the codes to sink to the “lowest common denominator.”
3. Clarity of Communications
The business world is full of important communications. Companies constantly communicate with numerous audiences by a variety of means. Clarity in these communications is a sign of a well-run business and a healthy corporate culture. Fuzzy language is often a pretty indicator of fuzzy thinking.
For the board of directors to discharge its responsibilities, management must give directors clear information about the company’s strategy and its plans for execution. When (not if) problems arise, communications often break down, and what communication there is becomes unclear. The board must insist, in good times and bad, that management give the board concise, understandable information on a timely basis.
For its part, the board must be direct with management about what information it wants, and how and when it wants it. In setting policy, the board must be certain that management understands the policy, the rationale for it and how the board expects to see the policy implemented and its effectiveness measured.
Management should be clear with analysts and investors in describing the company’s strategy, plans and results. Confusion in the marketplace will generally lead to lack of confidence, and that will usually adversely affect shareholder value.
Clarity is also important in communications to customers. In advertising, marketing, promotions, labeling, warranties, disclaimers and customer relations, management should be sure customers know what they are buying and what they are not buying. Putting the bad news in the “fine print” is not likely to be a sensible long-term tactic. Bold print might do a better job.
Employees cannot be expected to perform unless they understand what is expected of them, and the consequences for them and the company of success and failure. To avoid misunderstanding, multiple communications, by various means may be necessary. When it comes to codes of conduct and compliance, effective communications should include the reasons for the rules and illustrative examples.
If management’s communications with regulators are straightforward, the company should gain a reputation for integrity that will pay off in the long run. Regulators will be around forever, and the regulatory, institutional memory is long. Regulators will discover and seize upon inconsistent company communications to various constituencies, e.g., investors, customers and employees.
4. Consent
Consent goes hand in hand with disclosure. It is often the next logical step. Consent is relevant with many constituencies, not just shareholders, but also employees, customers and suppliers.
Consent is not always required, as a matter of law, contract or otherwise. In many circumstances, it is not advisable or practicable to obtain consent. Consent may be implied in some situations, such as, when a customer has full and fair disclosure about the company’s products or services, and makes a purchase. In more sensitive contexts, such as, the confidentiality of personal medical or financial information, advance written consent may be more appropriate.
This is not to say that public companies should seek shareholder consent for actions that do not require shareholder consent as a matter of law. It also does not mean that companies should give counter-parties more consent rights than are customarily negotiated in commercial contracts or corporate transactions. The principle of consent may, however, be instructive in making decisions about the treatment of stakeholders. We know from our personal experience when we think that our consent is required, and how we feel when our consent is obtained and when is it not.
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