How to build organisational resilience to ethical risk using integrity based mechanisms and culture

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Whilst tactics to remain competitive in a modern commercial environment often influence the belief that behaving ethically is not profitable, I like to think that a series of global financial and corporate scandals involving the James Hardie Group, HIH and the Australian Wheat Board has accelerated a new social mantra, that society expects business to be trustworthy and avoid harming others, even if it is lawful to do so.

If this is a myth, then let’s try it from another angle and consider the sheer cost to organisations of a lapse in organisational integrity in terms of money, distraction and reputation, as evidenced recently with the failure of organisations such as the Storm Financial Group.

The stakes are high. Poor ethical decision-making and unethical behaviour can be a function of a lack of organisational commitment or structure to establish an effective culture, where boundaries surrounding appropriate behaviour are well understood. This structure is only found in part in a traditional legal compliance framework, partly because its focus is on minimum behavioural boundaries, usually those set by the law.

Whilst compliance with the law is a necessary corporate motivator, history has shown it does not seek to improve general human excellence and distinction, nor does it guarantee business integrity and protection from all risks1.

Indeed compliance with the law represents a minimum standard of corporate performance that may fail to respond to key stakeholder expectations, such as Regulators and clients2. For example, whilst there is a legal requirement to disclose commissions and alternative remuneration payments made by third party financial product providers to financial advisers for the commercial sale of financial products to clients, the current view of some stakeholders is that these payments represent an inherent conflict of interest that should be
avoided by banning such payments.3

Promoting an ethical culture by rewarding ethical activities and by giving signals to employees/advisers that the organisation expects certain types of behaviour in certain situations, can be a positive force on individual behaviour and decision-making.4 It may also go some way to reducing the organisational costs of an integrity lapse and move organisations beyond compliance towards that new social mantra I spoke of earlier.

The importance of Ethical Culture to an effective business model

So what is ethical culture in theory and how can organisations influence that culture to achieve positive ethical outcomes within their organisations in reality.

I define the ethical culture of an organisation as a sub set of organisational culture. Theoretically, the ethical culture of an organisation is often articulated in the formal and informal systems of an organisation that are capable of promoting ethical or unethical behaviour.5 These formal systems include policies and procedures such as codes of ethics, authority and reporting structures, performance management systems, training and induction programs. Informal systems include expectations and perceptions about obedience to legitimate authority, peer behaviour and other ethical norms.6

These formal and informal systems define acceptable and unacceptable ethical behaviour for staff, agents and stakeholders of the organisation and can either promote a healthy or unhealthy ethical culture. Research7 has indicated that ethical behaviour should be higher in organisations where leaders and norms encourage, support and reward ethical conduct and discourage and punish unethical conduct through these systems.

Organisations which focus on a legal compliance framework to ensure they meet legal and ethical obligations also run the risk they will be viewed by stakeholders in the future as implicitly endorsing a code of moral mediocrity for their organisations. Enter again my proposition of a new social mantra. Even so, the failure to integrate compliance and ethical obligations into an organisational culture can be significant.8

Implementing the Right Systems and Procedures

So what kinds of systems and procedures should an organisation implement in order to make a difference? The Australian Standard on Fraud and Corruption Control9 8001-2003 and Appendix B of AS 8000 Good Governance Principles are a good start. These documents discuss eleven elements required for a sound ethical culture including an ethical framework, codes of behaviour, allocation of responsibilities, the establishment of ethics committees, communication, training, reinforcement and benchmarking, reporting of complaints and leadership and role modelling from the senior management group.

These are similar elements to those measured by the Ethics Resource Centre, EthicsCulture Survey (2003) and are also found in the Corporate Governance Principles of the Australian Stock Exchange.10

Whilst these Australian standards are not mandatory, they provide significant guidance and assistance concerning the establishment, operation and maintenance of such systems in an Australian context.

My recent PhD research on ethical decision-making within financial services organisations asked both financial planners and compliance officers to indicate the systems and procedures currently in place within their AFS Licensee that were related to ethical culture.

The Table below highlights nine ethical cultural systems and procedures required by the Australian Standard on Fraud and Corruption Control. Column three documents the percentage of respondents who positively identified their AFS Licensee as having that system. Column 4 shows the percentage of respondents who either answered “No” or “Don’t Know” to the question posed.

Table: Response rates concerning ethical culture systems and procedures within Australian Financial Services Organisations.

This data suggests that the financial services organisations that were the subject of the PhD survey appear to have traditional and overt ethical culture mechanisms in place, such as internal codes of ethics/conduct (81.8%); published sets of organisational values (78.2%); adviser training in ethics (73.9%) and whistleblower policies (77.0%).

Yet less than 50% of respondents believed their AFS Licensee referred to the ethical standards expected of staff in their performance systems (Q.7 – 47.9%); had regular reporting on ethical matters within the organisation (Q.5 – 47.9%) and had implemented formal reward systems for ethical conduct (Q.9 – 21.2%). There was also a very low “yes” response rate of 51.5% to Question 6 (Does the Licensee have enforcement mechanisms such as a staff /adviser disciplinary policy?).

The table reflects a 60.2% range between the highest score of 81.8% for the presence of an internal Code of Ethics/ Code of Conduct (Q1) within AFS Licensees, to 21.2% for the presence of formal reward systems for ethical conduct (Q.9).

Given the presence of all nine systems and procedures within an organisation at a minimum and their enforcement through action and leadership can reduce the occurrence of unethical behaviour and poor decision-making, the results outlined in the table are surprising and suggest that there is a current gap in this area.

The question that remains is how effective are the systems and procedures in instilling the organisation’s ethical values and conduct standards into every day practice even when they are in place? The answer may lie in whether the values and standards are communicated, reinforced and upheld. It may also depend on whether those values and standards are exercised by those in positions of authority or whether other organisational norms are allowed to send inconsistent messages.

The data from the survey seems to answer these questions in the negative. Within the financial services organisations studied, the regular reporting of ethical matters was very low (Q.5 – 46.7%). Further, nearly 40% of respondents did not believe or did not know whether their AFS Licensee even had enforcement mechanisms, such as a staff /adviser disciplinary policy (Q.6 – 39.4% No or Don’t know).

If these results are representative of a lack of enforcement mechanisms across organisations, this may be compounding the ability of compliance officers and management to take enforcement action against unethical staff. However, even when such systems are in place, a focus group of respondents conducted as part of the PhD study, perceived that a lack of organisational will to use enforcement mechanisms was one of the top five ethical dilemmas facing management.

These results also demonstrate that some conventional mechanisms, which may assist management and compliance officers in instilling and enforcing a strong organisational ethical culture, may be lacking within organisations. This includes systems and procedures linking ethical behaviour with performance and reward systems.

Further, it can be inferred from the results that the communication and reinforcement of ethical values and behaviour within organisations may be lacking. It is difficult otherwise to reconcile that 71.5% of respondents answered either “No” or “Don’t Know” to question 9, concerning whether people who achieve high levels of ethical conduct within financial services organisations are rewarded.

Whilst offering rewards for ethical behaviour does not necessarily increase that behaviour11, a lack of mechanisms for rewarding ethical conduct in circumstances where there are rewards for reaching pecuniary targets, may send ambiguous messages to an organisation’s staff and agents as to which behaviour is valued more highly, with bonuses and other rewards for meeting sales and finance targets thought to adversely influence ethical decision-making.

The Australian Standard on Fraud and Corruption is not mandatory and its application is subject to size and turnover requirements, amongst other conditions. However, ASIC Regulatory Guide 164 (ASIC 2002a) envisages that AFS Licensees should use such standards as a guide to assist them to meet licensing obligations and to promote a culture of compliance. In addition, the Australian Standard on Compliance Systems 3806-200612 expects organisations to commit to full compliance with laws, industry standards and ethical obligations. Accordingly, the finding of such low rates of compliance with this Australian
Standard amongst the AFS Licensees that were the subject of the PhD study was surprising.

So Lets Recap

There may be a significant gap between the types of formal and informal systems that are in place within financial services organisations related to ethical culture and those that would be expected to be in place pursuant to the relevant Australian corporate standards.

My suggestion: take my test and answer the nine questions used in the PhD survey. Then ask yourself:

  1. Does our current compliance framework include these systems and procedures?
  2. How do we communicate the organization’s values to staff and report on ethical risk?
  3. Have we linked outcomes from compliance audits to performance management systems and do those audits include reference to key indicators concerning ethicalconduct and citizenship?
  4. Are we able to effectively use enforcement mechanisms to discipline those who engage in unethical conduct?

The implementation of the formal and informal systems and procedures identified in this article will influence ethical behavior and decision-making within your organization. It will assist you to build organizational resilience to ethical risk within your business and to establish behavioural and decision-making boundaries required for staff and agents alike.

FOOTNOTES

1 Petrick, J. A. & Quinn, J. F. 1997, Management Ethics: Integrity at Work, Sage Series on Business Ethics, Sage Publications Inc, Newbury Park, California
2Etkind, S. 2005, ‘Global round up’, Financial Services Newsletter, vol. 4 no. 2, Lexis Nexis, Sydney, p. 28
3 Taylor, M. 2005, ‘ACA reopens commissions debate’, 6 October, viewed http://www.superreview.com.au/articles, on 7 October
4 Weber J. 1993, ‘Institutionalising ethics into business organisations: A model and research agenda ‘, Business Ethics Quarterly, vol.3, issue 4, pp. 419-436

5 Trevino L. K. & Youngblood, S. A. 1990, ‘Bad apples in bad barrels: A causal analysis of ethical decision making behaviours’, Journal of Applied Psychology, vol.75, pp. 378-385.
6 Trevino, Butterfield and McCabe, 1998, ‘The ethical context in organisations: Influences on employee attitudes and behaviors’, Business Ethics Quarterly, vol.8, issue 3, pp. 447-476.
7 Ethics Resource Center 2005, ‘The 2005 National Business Ethics Survey’, Ethics Resource Centre, Arlington, Virginia, May 21, p 78; p 80.
8 Owen, N. 2003, Final Report: Royal Commission into HIH Insurance Group, Government Printer, Canberra
9 Standards Australia, 2003a, AS 8000-2000: Australian Standard on Good Governance Principles, 23 June, Standards Australia International, Sydney. Standards Australia, 2003b, AS 8001-2003: Australian Standard:
Fraud and Corruption Control, 23 June, Standards Australia International, Sydney.
10 Australian Stock Exchange Corporate Governance Council, 2007, Corporate Governance Principles and
Recommendations, 2nd edition, ASX Corporate Governance Council, Sydney

11 Trevino & Youngblood 1990, op cit.
12 Standards Australia, 2006, Compliance Programs AS3806-2006, March, Standards Australia, Sydney.

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