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Thursday , October 02 , 2014
You are here:  The Ethics Perspective

Enron

        

© Paul Arveson, 2002

In the fall of 2001, Americans experienced a new depth of evil. Following the attacks on two cities, the mail system was attacked with Anthrax and electronic systems were attacked with the CodeRed and other viruses. We have a new awareness of forces that seek to do unlimited harm to society. We sense that we are quite vulnerable to random attacks in a variety of ways, and it is unlikely that the government can stop all of them.

But our society has also been subjected to a threat which appears to have had a more serious and lasting effect on our economy than the terrorist attacks. Some corporations have defrauded the public on the unprecedented scale of many billions of dollars. We have witnessed the consequences of conflicts of interest by auditors and stockbrokers. Piracy of software and music is widespread across the Internet, and counterfeiting of prescription drugs is leading to many deaths. Bogus "alternative" medicines and phony diet treatments are everywhere. Our regulatory institutions, such as the Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC) and the Food and Drug Administration (FDA), seem unable to respond adequately to these new forces of fraud.

The Mercatus Report on Government Accountability for 1999 concluded:

"... Government has the same fiduciary responsibility to taxpayers that companies have to their shareholders. Agency reports should mirror standards required in the reports of Fortune 500 companies, which suffer severe penalties if they fail to report accurately and ethically to their shareholders."

How ironic it is, in these post-Enron times, that the regulatory status of the private sector would be held up as a standard for government accountability! Criminal and civil litigation against Enron, Andersen, and other corporations is likely to continue for many years, with billions of dollars at stake.

In a first effort to restore trust in corporations, the Sarbanes-Oxley Act now requires the CEOs and CFOs of large corporations to sign an affidavit certifying the accuracy of their financial reports. They must certify that to the best of their knowledge, "No covered report contained an untrue statement of material fact ..."

But how can executives know for sure that everything in these reports is true? Of course, assuring this is the reason for the enormous effort and cost that goes into the maintenance of accurate accounting data in any organization, along with independent audits and inspections. However, as we have seen, financial audits can be misleading or untrustworthy. Loss of credibility has led to the collapase of at least one major accounting firm, and the breakup of others. In the wake of these accounting scandals, it is evident that fraud or at least misleading statements are widely distributed in companies. The suspicion of this -- whether justified or not -- is causing a retreat of investors from the entire stock market.

We have learned once again that the crucial factor for economic health is trust. Without trust, business could not function, and the economy would degenerate back to barter. It is this assault on our sense of trust, more than the overt acts of terrorism, that has created a lasting downward pressure on markets.

"Trust but Verify"

Corporate governance has become an important new concern in our society.  But signed affidavits do not by themselves justify trust. Legislation alone, although beneficial and well-intended, cannot guarantee trust. The size and complexity of modern corporations and governmental organizations is such that no one can know everything that is going on. Executives have to trust their subordinates and vice versa. Inspectors and auditors have to invest a significant amount of trust in those who supply them with documents. And investors have to trust the information provided to them by company managers. Even a police state like the Soviet Union could not know enough about its people, and it collapsed under its own weight. A society, to be a society, must depend on the internalized "good faith" and trust of a significant majority of its members.

Trust is also extremely important in the technologies we use to share information. We can use "secure" means of communication, such as encryption and digital certificates, but how can we verify that our networks are truly secure? Often in recent times we have discovered, too late, holes and security lapses that we had assumed were not there. In the wake of heavy criticism, even Microsoft's Bill Gates has distributed his thoughts about the need for "trustworthy computing". But he only refers to the technical aspects of security. This alone is an insufficient guarantee. As long as human beings are involved in a process, there will be the possibility of deceit.

The original balanced scorecard emphasized the importance of employee learning and growth as the foundation of success, and the source of innovation that leads to target-breaking performance. This is certainly valid, but recall that the managers of Enron were all highly educated professionals. Yet their education served only to make them more clever and evasive in building a fradulent corporation. Education is not enough.

Sound business ethics must be practiced in order to rebuild trust in a company, and in our entire economic system. Underlying all of the other features of a healthy organization, there must be an abundance of good will, transparency and ethical behavior. Because of the pervasive importance of customer and investor trust, I suggest that ethical business behavior should be included in the "learning and growth" perspective of the balanced scorecard, or that an ethical business culture should be added as a fifth perspective where appropriate.  

Measures of Corporate Ethics

But how can you measure ethical performance? Balanced scorecard designers, of course, routinely encounter aspects of performance that are qualitative and hard to measure. Perhaps this is the hardest - but it is not impossible. Based on the principles that "he who is faithful in the least will be faithful also in much" and "a tree is known by its fruit", here are some possible metrics to consider (metrics with asterisks (*) are also relevant in public-sector organizations):

 

Metric

Rationale

Level of business ethics training* Modern business is complex; we must not assume that the rules of ethical behavior are known without training and evaluation of employees. This could also include training on the company's own business principles.
Morale of employees* If a company doesn't treat its own employees fairly, how fair can it be to outsiders?
Openness, transparency* Do executives hide behind spin and obfuscation?  Is there a lot of secrecy?
Candor* Do leaders report bad news as well as good news? Are they self-critical? Do they take responsibility?
Turnover rate* If high, may indicate employee dissatisfaction.
Union relations* If constantly strained, may indicate perceptions of distrust by employees.
Hotline* Do employees have access to an anonymous communication channel to managers or inspectors?
Nepotism* It may be more likely for family members to share dishonest practices, to exclude more-qualified managers, or to be distracted by infighting.
Community involvement* Do the managers care about their neighbors?
Criminal records* Public records may be available for some executives.
Driving records* Bad driving may be a symptom of other problems.
Extravagance* Managers' use of corporate resources, opulence of buildings, homes, etc. may be excessive.
Environmental awareness* Do they leave all the lights on? Do they recycle? Do they pollute?
Employee policies* Are employee policies in line with industry, or excessively stringent?
Resignations* Executive resignations, other than for age, may indicate conflicts.
Employee diversity* Is it representative of the general population?
Whistleblowers* If any, what are they saying? How are they treated?
Inspectors, Regulators* US govt. agencies - see Inspector General reports. Stock investors should check the EDGAR database. For occupational safety, check for OSHA violations. For foods and drugs, check the FDA. For consumer products, check CPSC. For vehicles, check NHTSA.
Transparency* Financial and related company data should be reported frequently and openly on web sites.
Charitable giving; foundations Altruistic behavior is difficult for crooks.
Work hours Long hours mean stressed employees.
Lobbying expenses Excessive, multi-party lobbying efforts were an Enron trademark.
Legal expenses Too many lawsuits and lawyers on the payroll may indicate a defensive or aggressive culture.
Insider trading New rules require prompt reporting within days.
Taxes paid No taxes? Maybe the company is being too clever.
Cash flow Better indicator of health than stock price.
Dividends Company cannot cheat with payouts of dividends.
401(K) plans May employees invest other than in company stock?
Stock options Are they expensed?
Bond ratings Indicates analysts' estimates of company's ability to pay its debts.
Social responsibility Is company stock included in a socially responsible mutual fund? (See lists)

A collection of such metrics may show trends that are not visible in corporate annual reports or on the resumes of distinguished executives. But these traditional sources of data have recently been found to be lacking and misleading. Behavior-based metrics such as the above may provide a better overall view of the level of corporate ethical culture. (Of course, there are no guaranteesthat these metrics will be sufficient indicators of trustworthy or ethical behavior). As much as we know that clever people can deceive, we also know we must depend on clever people to expose deceit.