Ethics Resource Center

Published: March 25, 2010

Column:
The Importance of Leadership in Times of Crisis
By Patricia J. Harned, Ph.D., President, ERC

Every research study yields some surprises, but we never expected to see findings like the ones resulting from the 2009 update to our National Business Ethics Survey (NBES).  One of the largest surprises was the apparent link between the state of the nation’s economy and the strength of ethics in the workplace. 

When we set out to collect data in the aftermath of the recent financial collapse, we expected to see ethics in radical decline.  We figured people would turn to cheating in order to stay afloat, and we expected backlash from cost cutting in the face of a grim economic outlook.  What we discovered was the exact opposite; in these tough times businesses seemed to be running tighter ships, ethically speaking.  Leaders are more explicit about ethics as a priority, ethical cultures are stronger and misconduct in the workplace is down. 

Looking back over past NBES data, we saw that this was the same trend that we tried to explain in the 2003 NBES, following the dot-com crash in the early aughts.
Both eras were defined not only by financial turbulence, but also by high profile ethical failings on the part of business executives.  The first period was marked by accounting scandals at Enron, WorldCom and Adelphia which led to prominent figures finding themselves behind bars. 

In contrast, with the exception of Bernie Madoff, the business leaders getting the most ink this most recent time around didn’t seem to commit criminal wrongdoing. But they certainly have been subject to a great deal of public scrutiny for making questionable decisions from an ethics perspective.  The accounting fraud early in the last decade had legislators looking for ways to tighten up on accounting fraud, a movement that led to the Sarbanes-Oxley Act of 2002 which required more in-depth financial reporting.  We can see the same type of reaction today in the movement to reform the financial services sector.

Another important outcome of the recent financial turmoil is discussion about executive compensation – “say on pay” is now a hot topic inside the Beltway.  During the January meeting of ERC’s Fellows Program, we had the chance to examine this issue more closely.  Former congressman and ERC’s board chair, Michael Oxley, discussed the impact of Sarbanes-Oxley and offered insight into the potential implications of executive compensation regulation. Kenneth Feinberg, Special Master for TARP Executive Compensation, described his role in determining payment structures for top executives at bailed-out firms and explained the limits of what he can accomplish. And in those meetings Oxley, Feinberg and John Castellani, president of the Business Roundtable, all agreed that while government regulations can react to problems like those we saw in 2001 and 2008, there will always be people who try to stay one step ahead and beat the system.

That creates a particular challenge for boards.  How can directors establish incentives for CEOs that reward performance, and yet safeguard against excessive risk taking?  The work Feinberg is doing with TARP firms is a step in the right direction; removing dangerous incentives that lead to unnecessary risk and shifting emphasis to long-term growth encourages good business practices.  However, we can do more. 

By determining what actions executives are taking during difficult times and incentivizing those behaviors, we can avoid what I’ve called an “ethics bubble” and instead build on the progress we’ve made.  In the 2009 NBES we saw that during tough times, leaders naturally guide their organizations in ways that employees perceive as setting very high ethical standards.  The challenge is to create incentives for these leaders so that they maintain that approach once the economy recovers and it is back to business as usual.  With executive compensation in the public consciousness, now is the time to discuss how to incentivize ethical leadership.

The value of leadership from directors, executives and board members is not to be understated.  We know from NBES that when employees perceive a strong positive tone coming from the top, misconduct is reduced by as much as 50 percent.

With this in mind, ERC recommends that corporate boards place a greater emphasis on the creation of a strong ethical culture, and take steps to link executive pay to ethical leadership.  Through the creation of an Ethics Committee of the Board, recruiting more ethics professionals for board positions and tying compensation to metrics measuring internal perceptions, directors can clearly communicate that they are doing more than simply paying ethics lip-service.

The creation of a strong ethical culture should not be taken lightly by executives, for the sake of their company’s future, certainly, but also for their own sake.  Data from the 2009 NBES clearly shows the link between the strength of culture and opinions on executive compensation.  Among employees in a workplace with a strong ethical culture 91 percent believed that executive compensation was at an appropriate level. This number steadily decreases with strength of culture, to the point where only 20 percent of employees in a weak culture believe compensation is appropriate.  Clearly executives would do well for themselves to foster a better climate in the workplace.

If we are able to take advantage of the opportunity we have as a result of this most recent financial crisis we may be able to move beyond treating the symptoms of unethical business practices and move toward preventing them in the first place.  It’s ironic, but recovery from our current situation isn’t the goal when it comes to ethics.

In This Issue

• The Importance of Leadership in Times of Crisis. Column By Patricia J. Harned, Ph.D. President, ERC
• Patricia J Harned, ERC President, testifies before the United States Sentencing Commission
  
• The Dark Side: Critical Cases on the Downside of Business. Book Review By Kyle Goetschius
  
• A Case for Cooperation: the Defense Industry Initiative
• ERC Honors the Late Carol Marshall with the 2009 Pace Award
• January Fellows Meeting Retrospective