The news over the past few years has been dominated by stories of massive frauds and Ponzi schemes—Enron, Bernie Madoff and Earl Jones to name a few. We have also witnessed spectacular investment meltdowns such as Long Term Capital Management and Amaranth. More recently, there has also been much discussion about the moral ambiguity of the actions of the credit ratings agencies and government lobbyists and their role in bringing about the very recent and painful credit crisis.
It is the topic of moral ambiguity that I find very interesting. When I took my MBA more than 20 years ago, business ethics courses were rarely offered or taken by students. My guess is it that we, as individuals, were presumed to already have been taught the basics of right and wrong and such courses were not needed. Yet most MBA programs now offer courses in business ethics.
The ever popular Wikipedia defines business ethics as a form of applied or professional ethics that examines ethical principles and moral and ethical problems that arise in a business environment. Interest in business ethics gained in popularity in the 1980’s and 1990’s, both within corporations and academia.
Whose ethics?
Milton Friedman believed that corporations have the obligation to make a profit within the framework of the legal system and nothing more. Business leaders should “make as much money as possible while conforming to the basic rules of the society, both those embodied in the law and those embodied in ethical custom”. Opposing views have taken the view that the law is usually reactive, that crime precedes law, and that legal procedures are rigid and obligatory unlike ethical acts which are voluntary and conscientious.
Post Enron, WorldCom and Tyco, many companies, large and small, appointed ethics officers whose responsibility was to assess the ethical implications of a company’s activities, recommend ethical policies and codes of conduct, and to disseminate information to employees. The ethics officer usually reported to the CEO directly. Companies began requiring employees to adopt a code of conduct, and in some cases, to attend seminars regarding appropriate business conduct. The Sarbanes-Oxley Act was passed as a result of the corporate scandals to help uncover unethical and illegal activities. Finally, many companies instituted the role of the risk officer to identify and manage risk in an effort to better monitor how shareholders’ investments might be affected by a company’s decisions.
One would think that with all these actions, we would see less evidence of corrupt and illegal activity. Yet, the very recent Madoff and Galleon situations suggest that we cannot institutionalize moral behaviour. Ethical business practices are usually the result of a corporate culture that supports and values ethical behaviour, and this is usually driven from the top down and supported by the individuals of the organization.
Ethics evolved
In the past, “socially responsible investing” had been limited to screening investments for financial and non-financial criteria based on an exhaustive set of “social” issues. Investors commonly excluded investment in companies that engaged in the manufacture, distribution or sales of the following products: alcohol and tobacco; pornography; gambling; armaments; nuclear power; pollution; animal testing, and more recently genetic engineering. Socially responsible investment screening was often requested by religious groups, endowments and foundations, although even then, the various groups often disagreed on what should be included and excluded.
More recently, the United Nations has developed Principles for Responsible Investing which more than 20 high profile organizations including the Canada Pension Plan Investment Board have adopted as part of their investment and monitoring programs. The Principles are intended to provide a best practice framework to help integrate consideration of environmental, social and governance factors into investor decision-making and ownership practices, thereby improving long-term returns to beneficiaries. Their fundamental belief is that companies that manage environmental, social and governance factors are likely to have better long-term financial performance. In other words, there appears to be a direct link between good governance and long-term returns.
One subset of this is corporate activism, which has gained steam following many of the management and board excesses. Corporate activism has many aspects to it, including proactively exercising voting rights to influence corporate policies; agitating to change the way board elections are held; actively engaging companies on the way they deal with social, environmental and ethical matters; and building up an investment position to address from within governance deficiencies and to unlock potential shareholder value. Perhaps one of the most well known of those who engage in the latter is Kirk Kerkorian.
In Canada, the Coalition for Good Governance has been an early supporter of many of these initiatives. What we are witnessing now is a broader acceptance within society and the investment community of the need for more ethical corporate cultures and good corporate governance practices. As was already noted, rules, practices and even supportive cultures are no replacement for people who act in an ethical manner. There will always be a portion of the population who will act in a self interested fashion. We just have to make it harder for them to do so.
It is also worth noting that we live in a global village now. The whole system of corporate governance, ethics and responsible investing is founded on Western values and morals. Other cultures do not always share the same values and will act in a different fashion. As economic power shifts from West to East, the scale by which we judge individual and corporate behavior may have to adjust as well. It will be interesting to see how we adapt our governance and investment practices to this situation.