NON-COMPLIANCE IS STRANGLING FIRM PERFORMANCE
MSc Sandra Damijan,
Ljubljana (Faculty of Economics), Slovenia
Abstract
Just like in the old robber baron days, today buddy capitalism and corporate corruption is
front-page throughout the world. Deregulation, especially in the financial markets, has distorted
incentives and exposed conflicts of interest among market participants. Corporate environments are
increasingly getting divorced from values and morals. What do ethics have to do with compliance?
A lot. Because ethics is the foundation for law. Poor ethical culture breeds integrity breaches, which
then often lead to legal violations and too often accompanying financial collapse. So, how do
companies make sure they do not go down this path? The answer lies in introducing efficient and
cost-effective system of corporate integrity. Companies with higher integrity standards perform
better. They experience greater profits, have lower labor cost and higher shareholder returns.
Employees work harder, are more innovative as they are in trust environment. Employees have
better relationship among themselves, with management. They are proud to contribute to company’s
success that also shows through their loyalty to it. Last but not the least, investors want now more
than ever to have ethical investments.
Regulatory framework exists and benefits of implementing efficient system of corporate
integrity are more than apparent. However, the biggest obstacles companies face are their selflimited beliefs and neglect of its importance.
KEYWORDS: corporate integrity, firm performance, corruption, ethics.
1. Introduction
Consider this. You are an investor searching for purchase of high valued company stock.
After reading external revision report of well recognized auditing firm, you decide to invest in
military company that has USD 30 million profit, USD 145 million of assets, USD 77 million
ownership capital (ROE 39%), 675 employees. The company has been for sixty years recognized
for quality business earning awards such as sustainability reporting, pwc stakeholder
communication, etc. CEO of the company has big business ambitions, wants to expand to other
markets and does not have time with this new trend of introducing corporate compliance. Would
you invest? Most of us would. Shortly, this would show as very bad business investment. The CEO
of the company would be arrested for embezzling company funds. The stock prices would
immediately drop and we would lose large sums of money.
Unfortunately, many investors lost this money in 2007. Above mentioned is the case of
company DHB Industries, the leading body armor provider to U.S. soldiers in Iraq, whose CEO
David Brooks was arrested based on 21 counts of alleged securities fraud, insider trading, tax
evasion and obstruction of justice. He inflated his company stock and bilked his firm out of tens of
millions of dollars to bankroll his fairy tale lifestyle.
This is not a lonely case. Just like in the old robber baron days, today buddy capitalism and
corporate corruption is front-page throughout the world. This naturally raises the question of what is
responsible for this trend. Is the surge in corporate corruption a result of the extensive University of
market deregulation of the last two decades or a reflection of the increased corporate appetite and
no integrity?
Some argue that that corporate wrongdoing has today come to be seen as a routine occurrence
and is no longer surprise. According to Transparency International, nearly three people in four
believe that corruption has increased over the last few years. Others take different position that
things have never been cleaner. What has changed is how strenuously governments are cracking
down on corruption.
Whether glass is half empty or half full depends on how you look at it. But the answer lies
somewhere in between. While the intensity of regulatory crackdowns has risen, it cannot be denied
that there has been a proliferation of corporate misdemeanors in recent years. Deregulation,
especially in the financial markets, has distorted incentives and exposed conflicts of interest among
market participants. Corporate environments are increasingly getting divorced from values and
morals.
2. Bad apple or bad orchard?
Good employees at great companies often can be driven to do really unethical things and
breach the integrity. We can all be occasionally bad apples. Sometimes it is because we employ
multiple roles, where we hold ourselves to different standards (i.e. home vs. work). Or we lack
courage to do what is right, or do not have all of the information we need and in the end our choice
we make might look unethical. And yes, we can all make mistakes. Our wrongdoing is not
necessarily evidence of a bad intent.
Much greater problem is when we question our ethical choices if majority is acting
differently, when we make consensus with the company bad orchard. It is that phase when a
company is in danger, on its way to collapse. The red flags are when you hear employees in
company repeating I do not get paid enough, They owe me, No one will know, No one will be
interested, and similar.
What do ethics have to do with compliance? A lot. Because ethics is the foundation for law.
Poor ethical culture breeds integrity breaches, which then often lead to legal violations and too often
accompanying financial collapse. Moreover, just because something is legal, does not mean it is
ethical. Rules are necessary but not sufficient. The rule-based system is at best reactive, preventing
a recurrence of a problem that is also known as compliance. It is falsely predicated on being able to
anticipate each situation. This is where ethics based system enters. The latter is truly proactive,
equipping employees with knowledge on how to deal with ethical situations.
In reality companies must have both systems in place. If a behavior or an action is legal, it
does not mean that it is ethical. However, rules are not intuitive. If behavior or action breaches
rules, you cannot rely on your moral senses. In order not to have too many bad apples in the
company that would eventually rotten other employees we need to trust each other within company,
to trust in company’s strong professionalism, commitment to ethics, avoid preferential treatments,
not to deviate from right doing, to have strong sense of loyalty to company and its employees. If the
system is set up on these values, bad apples will leave themselves. So, how do you identify these
bad apples? The answer lies in introducing efficient and cost-effective system of corporate integrity.
3. Walking the talk
It is not enough for companies to be aware of integrity meaning on a paper, they also have to
make sure their employees are complying with laws and daily behaving so they do not expose the
company to potentially costly headaches.
Companies will often say that they have ramped up their compliance programs because of the
recent trend on cracking down on corruption, fraud, and other irregular activities. The truth is many
companies only talk and only few walk the talk. This does not safeguard companies from becoming
unsuccessful corporate story. Past is the evidence, remember DHB Industries, Enron, WorldCom,
Siemens and more recent such as Wal-Mart, Goldman Sachs, Glaxo SmithKline, BP, Barclays, etc.
After being exposed for wrongdoings, their business performance decreased. Some picked up by
introducing efficient corporate compliance, while others are no longer among listed companies.
Research published in 2012 by the Center of Ethical and Legal Compliance confirms
companies with higher integrity standards perform better. They experience greater profits, have
lower labor cost and higher shareholder returns (Graph 1).
Graph 1
Source: CELC 2012
Efficient corporate integrity is detrimental for better performance. Employees work harder,
are more innovative as they are in trust environment. Employees have better relationship among
themselves, with management. They are proud to contribute to company’s success that also shows
through their loyalty to it. Last but not the least, investors want now more than ever to have ethical
investments.
Furthermore, the same research shows areas where »rotten apples« should be looked for and
which areas are most vulnerable (Graph 2). Most misconduct is HR related and more specifically
related to preferential treatment. A misuse of corporate assets follows together with the conflicts of
interest. Other misconducts are less frequent but it does not mean that their impact is less
detrimental for the company.
Graph 2
Source: CELC 2012
Companies that are still procrastinating in implementing system of corporate integrity will
very soon have to do it. Globalization and emerging markets give companies no other options if
they would like perform better, to attract investors or to even exist. Countries are increasingly
implementing anti-corruption and anti-fraud regulation; they communicate, have joint investigations
and prosecute corporate misdeeds between countries. There is evidence of stepped up efforts to
align corruption and fraud awareness, whether locally or in foreign countries, with compliance and
ethics systems in place. Regulation has been adopted across countries to adopt comprehensive
ethics programs (i.e. the Foreign Corrupt Practices Act ), to make companies automatically liable
for bribes paid on their behalf and to face criminal sanctions if they can- not demonstrate adequate
ethics and compliance programs are in place (i.e. UK Bribery Act of 2010), to reward
whistleblowers for reporting information (i.e. the Dodd-Frank Wall Street Reform and Consumer
Protection Act ), just to name few among other national regulations.
Regulatory framework exists and benefits of implementing efficient system of corporate
integrity are more than apparent. However, the biggest obstacles companies face are their self
limited beliefs and neglect of its importance.
4. Bridging the gap
Efficient system of corporate integrity connects policies and actions that company takes to
secure business opportunities. It represents constant learning, prevention and detection of
vulnerabilities, with a goal to guide companies and its employees’ daily behavior towards its
competitors, suppliers, distributors, and clients in order to secure full respect of legal and ethical
business conduct. There are many ways how company can achieve this. Among them is well-known
guidance on how to craft a strong compliance system published by the Organization for Economic
Co-operation and Development (OECD Good Practice Guidance on Internal Controls, Ethics and
Compliance). There is no universal agreement on one type of corporate integrity system. More
important is that companies implement what is efficient for them in terms of cost-effectiveness,
practicability and true vulnerability management.
Identification of compliance assessment areas (mapping) is first step. If company does not
know what to measure, it does not understand its vulnerability and it cannot control it. And if
company cannot control vulnerability, it cannot improve its performance.
Company should at least map two compliance risk group areas with its subgroups. First group
relates to general business conduct: Corporate governance; Financial accounting/Internal controls;
Public procurement/Government contracts; HRM; Records and Information Management;
Security/IT security; Intellectual Property; Third parties; and Social Media Related-Risk. Second
group relates to corporate integrity: Anti-Bribery/“Greasing wheels”/Extortion; Money Laundering;
Conflicts of Interest; Gifts/Hospitality/ Business trips; Code of ethics; Political contributions;
Donations/Sponsorships; Whistleblowers protection/Mobbing.
Where to go from mapping the compliance areas is typical approach of risk assessment.
Company should assess vulnerabilities of the areas, identify measures for addressing identified
vulnerabilities, and monitor their implementation. Typical assessment tools include interviews,
questionnaires, focus groups, cross-checking and other reviews depending on the company
resources capability. However, work does not stop here, it only begins. Knowing what are
vulnerabilities and what controls to put in place is first and important step. Building efficient system
of corporate integrity requires company to educate its employees on vulnerabilities and to
continuously maintain its ethics and trust.
Corporate integrity system of this sort will result in company’s better performance. On the
contrary, those companies that see it simply as a mean of reducing liability in situations where they
get caught will soon learn the reality of corruption and its costs.
So why does this all matter for ethical business thinkers and professionals? Because a strong
internal compliance program should be an integrated part of companies daily policies. They should
be able to identify and mitigate against corrupt behaviour not only to ensure compliance with the
law, but also to keep markets competitive and to ensure that their activities are benefiting the
societies in which they operate.