NACD - National Association of Corporate Directors
Strategy and Risk

Ethical Warning Signs Directors Should Watch For

by Jim DeLoach |

james deloach

Jim DeLoach

While ethical and responsible business behavior doesn’t guarantee immediate success, it builds a solid foundation for sustainable success. In fulfilling their responsibilities to ensure management sets the proper tone for the organization, directors should watch out for these warning signs:

The extent to which the code of conduct is emphasized and reinforced. There is little value in a code that is published but not regularly reinforced by management at all levels of the company.

The manner in which management engages the board. Management’s relationship with the board could be a sign of how it engages with employees. The board learns a lot if it rarely hears bad news until it’s too late; management only presents plans for approval, rarely seeking advice as plans are developed; the CEO controls the board’s agenda; board meetings are highly regimented; insufficient board agenda time is devoted to forward-looking strategic and policy issues; and/or the CEO is intractable when dealing with matters of concern to directors. If any of these signs exist, do they indicate how management works with subordinates? Are they a sign that the CEO doesn’t really listen? Do they foreshadow the organization is lagging in a rapidly changing marketplace?

Tolerance of a culture that could breed dysfunctional or illegal behavior. Unless effectively managed and balanced, past successes and growth along with sustained pressures to perform can breed a warrior culture and a cavalier attitude that spawns reckless risk-taking, institutional resistance to bad news, a dangerous lack of change readiness, variable compensation plans linked to unrealistic goals, a culture of arrogance, and lack of attention to protecting reputation and brand image. In their 2000 annual report letter, Enron Corp.’s top two leaders, Ken Lay and Jeff Skilling, wrote: “Enron is laser-focused on earnings per share.” Their emphasis on a single accounting measure is an integral part of the nexus that contributed to Enron’s fraudulent behavior that ultimately ruined the company.

Evidence that senior management lacks credibility with employees. Such evidence can surface in employee surveys conducted by an independent consultant. When the board notes that the CEO and executive management are unable to discern or are unwilling to admit when a strategy is not working or when execution of the strategy is failing, employees likely have noted it as well. A lack of management credibility can lead to loss of vital talent needed to sustain success.


Evidence that certain business activities may be out of control. For example, is there direct or anecdotal evidence of high-pressure sales practices, bullying negotiation tactics, disregard of regulatory authority, application of questionable accounting techniques, or other similar activities to further the organization’s interests? If these conditions persist unabated, they may lead to illegal acts, brand erosion, or other serious long-term problems.

The identification of product or process failures and other problem areas. When a significant product or process failure occurs—resulting in massive product recalls, mega warranty costs, embarrassing supply-chain disclosures, high-profile environmental disasters, or other issues driving a high-persistence wave of reputation hits— is it a symptom of an ethical breakdown upstream in the organization’s processes? If not, does it indicate a lack of clarity in priorities and conflicting metrics that, if addressed, might have helped mitigate the problem or even avoided it altogether? For example, is there a culture deep in the organization in which demanding cost and schedule targets could trump public and environmental safety issues?

Lack of follow-up on matters requiring attention. Is there evidence that management passively reacts to financial reporting control deficiencies, process incongruities, customer complaints, lack of adherence to policies and procedures, and other matters raised by whistleblowers, regulators, and internal and external auditors?

While these red flags are not intended to be exhaustive, they indicate potential integrity issues that require attention in an executive session to determine whether further investigation is warranted. Where there is smoke, there may be fire.


Jim DeLoach is a managing director with Protiviti (www. protiviti.com), a global consulting firm.

 

This story is from the September/October 2015 issue of NACD Directorship magazine.