Beyond Compliance – Creating an
ethical business environment

(Speech at OECD-SECODAM Conference on corruption; Mexico City, September 19, 2002)

Good afternoon, ladies and gentlemen. I'd like to thank the officials from SECODAM and OECD for organising this conference and the sponsors for their support.

I am delighted to have the opportunity to contribute some thoughts to this very important debate.

The title of my talk is "Beyond Compliance", so you might reasonably ask the question: Why, should companies in Mexico go to the trouble and expense of doing more than they are required to do by law? Is there a business case for creating an ethical environment within a company?

I will try to provide some answers to those questions and then go on to look at what companies need to do to establish a code of ethics, how they can get their employees and other stakeholders to observe the code and how they can benefit from such a code.

In the context of this conference, the first reason to establish such codes is that if strong ethics pervade a company, its employees will be much less likely even to consider the idea of offering a bribe or engaging in other corrupt practices. So compliance becomes easier.

A second reason is that fund managers are increasingly looking at business ethics when deciding where to place investments. Recent events in some big corporations in the United States will inevitably lead to much greater scrutiny of this kind.

The third reason why ethics can affect companies' profitability is that ethical lapses pose a severe threat to their reputations which can have substantial financial costs. The other side of this coin is that a company whose brand is identified with a strong ethical culture can attract additional business.

For these three reasons, ethics are a necessity not a luxury.

I would like to focus particularly on my third point -- the issue of reputation.

Reputations can take years to build and minutes to lose.

The risk of losing a good reputation is much greater today than it was a decade ago. One reason for this is the collapse of Communism when many so-called "People's Democracies" or "Democratic Republics" became real democracies. Nongovernmental organizations sprang up all over the world and greater press freedom meant that they had journalists to whom they could tell their stories and who were now free to write about them. And much of their scrutiny became focused on behaviour of corporations.

At the same time, NGOs around the world could link up with their counterparts in the US and Europe through the new technology of the internet. Campaigners could now spread their message at the click of a mouse.

News of human rights, environmental or other abuses now move around the world almost as fast as the latest jokes about President Clinton's misbehaviour or President Bush's mispronunciations.

If companies or their employees deliberately break the law - and increasingly, that includes bribery -- they deserve to lose their reputations.

However, in other instances, companies lose their reputations without realising there is anything wrong until it is too late.

Reputations can be lost through acts by employees at any level that may not be criminal but demonstrate lack of business ethics or bad judgment. For global companies, laws, regulations and customs differ from country to country. There may be a temptation to exploit weak laws - especially in poorer countries -- in the quest for greater profitability.

Health and safety is an example. Union Carbide's reputation was massively harmed when an explosion at the company's Bhophal plant in India in December, 1984 led to the deaths of 3,000 people and serious injury to 200, 000 more in the surrounding community.

In other instances, inadequate product-labelling legislation, lack of regulatory safeguards against price fixing, and weak labour laws can lead to a dangerous mentality that says "This is the way it is done here - we need to do it this way too if we are to be competitive".

It is the internal culture of a company that will ultimately determine the risk to its reputation.

Think for a moment about the kinds of unethical behavior that occur within companies throughout the world but which are often tolerated. These include taking your wife to lunch and claiming it as a business expense or making an unnecessary business trip to a place where there is a good golf course. We could all think of dozens of other examples. Some people don't think that stealing from the company is really stealing, and their colleagues feel uncomfortable reporting these offences when they learn about them, but it all leads to an unethical culture.

When even seemingly minor unethical behaviour is tolerated and goes unpunished it breeds reputational risk.

Sometimes companies and their employees engage in unethical behaviour almost without realising it because they are simply continuing internal practices that have gone on for years or they get caught up in the cost and time pressures that the company imposes to meet deadlines and profit margin targets. They make bad moral judgments that can severely harm a company's reputation. They may realise it is wrong, but they adopt a "We probably won't get caught!" mentality.

A good self-test for individual employees to use is "Would I like to read about my actions in the newspapers?" or "How would my children feel if they knew I was doing this?"

Let me give you some examples of cases where the failure to ask the question "Is what we are doing ethical?" allowed some good people to make very wrong decisions.

In 1994, Intel released its first Pentium chip. During product development, the company discovered, after nearly two trillion random test calculations, that there was a bug in the chip's floating-point unit. The error, would affect the vast majority of PC users only once in 27,000 years, but it could compromise the safety of bridges and other structures where high degrees of accuracy are necessary.

The company's management faced a business decision. But they also faced an ethical one.

To declare the bug publicly would have cost Intel tens of millions of dollars, and so they decided to keep it secret.

Five months later, a mathematics professor at a small American college discovered the flaw. Before long it was on CNN. For weeks the company tried to avoid recalling the chip while Intel's stock price fell by 72 percent. Eventually the board reversed the company's decision. The cost was $475 million and a reputation, which took years to rebuild.

An extreme and disturbing case concerned the Pinto, manufactured by a former employer of mine, Ford Motor Company. From my six years with the company and the subsequent associations I have had with it, I would put Ford's corporate ethics at a very high level.

But in the early 1970s, Ford was trying to compete with imported small cars and was determined to produce a car that would weigh less than 2,000 lbs and sell for less than $2,000. Testing during product development revealed that the rear fuel tank often ruptured when struck from the rear at relatively low speed. What was happening was that the fuel tank was smashing into several studs that protruded from the rear axle housing, which punctured it and spilled petrol. The spilled fuel could then be ignited by sparks, and Ford engineers found that in 8 out of 11 crash tests, potentially catastrophic fires ensued. All three vehicles that survived the tests had been modified to protect the fuel tank.

The problem for Ford was that the modifications added weight and cost to the car. Internal memos, subsequently made public, showed that the company had conducted a cost benefit analysis.

They estimated that it would cost $11 a vehicle to fix all similarly designed cars and trucks with tanks behind the axle. Total cost: $137 million.

They also placed a value of $200,000 on each human life that could be saved and $67,000 on each burn injury that could be prevented in the estimated number of cars that would experience catastrophic accidents. That figure came to $49.5 million - compared with the $137 million it would cost to prevent the fiery accidents.

So, disregarding the ethical implications and focusing on their business priorities, they decided that the cost of the fix could not be justified and the cars were built without the protective axle housing.

Ford was eventually charged with reckless homicide in the case of three Indiana teenage girls who died in a fiery Pinto crash. While the jury found in favor of Ford, the company paid millions of dollars of damages in that and other civil cases, and production of the Pinto was abandoned.

Ford's reputation took a long time to recover. I knew the sort of people who were making these ghastly decisions. They were decent employees who got caught up in the momentum of a project that top management was determined to see succeed.

Let me give you another personal anecdote.

I spent three years working for Continental Bank in Chicago. It was the sixth largest US bank and was enjoying spectacular growth in earnings and assets. Everything that Continental did was successful. The culture was one of integrity, honesty and openness.

Nothing could surely go wrong.

But it did. An energy division loan officer called John Lytle was quietly taking loans originated by a very small bank in Oklahoma City onto Continental's books and taking kickbacks for doing it. A year or so after I left Continental, this little bank, Penn Square, went bankrupt and Continental suddenly discovered it had a lot of bad loans.

Under US banking law, nationally chartered banks are not allowed to have the equivalent of more than 10 percent of capital in loans to one borrower. Continental complied with this regulation, but no such rule applies to loans obtained from a single correspondent bank. Continental's internal auditors should have noticed, though, that it was imprudent to have the equivalent of a full 35 percent of capital in loans originating at Penn Square. The auditors should have been thinking "beyond compliance". John Lytle's immediate superiors should have known what he was up to. But such was the euphoric invulnerable spirit at Continental that no one noticed.

However, once the news broke, everyone else did notice. Being an Illinois bank where branches are prohibited, Continental had no retail deposit base. The markets reacted, and Continental had to pay more on its Certificates of Deposit. From then it was downhill all the way. Within 18 months Continental itself, the sixth largest bank in the US, had gone bankrupt.

There are two lessons from the Continental case. The internal auditors had a too narrow, mechanical approach to compliance. Any company that has this approach runs the risk of overlooking a threat to its reputation - and, in this case, its survival. The second was that there was a highly ethical atmosphere, but no written ethics code. There is always a danger of one bad apple destroying a reputation. A formal ethics code could have sensitized his colleagues to what John Lytle - who eventually went to prison -- was doing.

These are all big dramatic cases with devastating impact. But seemingly small ethical misjudgments can wreck reputations. And when reputations are lost, as these examples illustrate, companies can also suffer huge financial losses.

How then can a Mexican company protect itself from reputational risk, enhance its attractiveness to ethical investors and create an atmosphere where bribery and corruption is less likely to be tolerated?

Many companies now realize that they have obligations not only to shareholders, but to all their stakeholders - employees, suppliers, customers and their communities, as well as the natural environment. They are paying attention to a growing number of voluntary codes of conduct and know that to protect their reputations, every single employee must observe the highest possible ethical standards.

There are some excellent voluntary codes of conduct that are worth looking at for guidance. The UN Global Compact addresses human rights, labor and environmental issues. The Global Sullivan Principles and The Caux Round Table's Principles for Business each address a broad range of standards. I believe that the most comprehensive rules against which a company can benchmark its practices are the OECD's Guidelines for Multinational Enterprises, which are easily accessible from the OECD's website. These are increasingly being observed by companies in other OECD countries with which the Mexican private sector competes. I am sure that some Mexican companies that are working globally will already be familiar with the guidelines.

A good starting point for a company is to survey how its behavior is perceived in all the major markets where it operates, among all the major stakeholders I mentioned. This is expensive, but the most economical way of doing it is to conduct a combination of focus group studies, carefully targeted interviews, and broader sample opinion polls. This exercise will provide a baseline of what stakeholders think of the company's ethical standards. It should be followed by an internal review of existing practices to detect ethical weaknesses and other potential threats to the company's reputation.

The next step is to establish the company's own ethics code. There is no perfect way of doing this, but there are several characteristics that distinguish the most successful ones.

The first is that the CEO and top management must take the lead in establishing the code, and they must observe it scrupulously in their own behavior.

Second, the code should state very clearly what the company's obligations are to each of its stakeholder groups. In the case of employees, it should state employment conditions, and it should make it clear that staff who report illegal or unethical behavior will not be victimized. It can also spell out employees' ethical obligations to the company, including misuse of company assets and so on.

It is essential that employees play an active role in developing the ethics code. They must feel real ownership of the code and realize that it is in both their own and the company's interests for them to behave ethically. They need to appreciate that their future employment may depend on the company's reputation.

Once the code has been extensively debated and is finally published, every employee should receive a copy. Seminars should be held explaining the code, and it can also be included as part of the terms of employment when staff are hired. It should also form a part of induction training programs for new employees.

The challenge is to get every individual employee to focus on ethics. One way of doing this is to include an ethics exercise in the annual performance appraisal review process between a staff member and his or her manager. It may seem time consuming, but if each manager takes the trouble to think up an ethical dilemma that could face the staff member and then discuss this hypothetical case during the appraisal process, both the manager and the subordinate will remember the importance of observing high ethics.

It is critically important that the momentum is maintained beyond the initial establishment of the code. It is a real challenge to keep an awareness program going indefinitely in such a way that employees don't become cynical about it. Renewing and reissuing the code annually can help to achieve this. Many companies, especially in the United States, employ a full time ethics officer to maintain the code and with whom staff can discuss ethical issues.

Of course, a way in which people will be continually reminded of the code is if breaches are always investigated promptly and fairly and appropriate punishments, including dismissal, are enforced. All this has to be done in an atmosphere that does not create a climate of fear and suspicion. Many companies use a confidential telephone line through which employees can report abuses. Sometimes this works best when it is handled by an outside contractor to reassure staff of its confidentiality.

Coming back again to the title of my talk: "Beyond Compliance" - It is not enough for employees to observe rules; they must want to do so because they understand the broader purpose.

Once a company has established a strong ethical code, it should make it known to all its stakeholders. Take suppliers: a company is at risk from unethical behavior in the supply chain and may wish to encourage suppliers to adopt a similar code. Shareholders should all be sent a copy.

The code can also be publicized in the media. When a company does this, it is inviting journalists to test whether the code is just public relations or a real standard by which the company wants to be judged. Such scrutiny is healthy and should encourage employees not to act in ways that will let the company down. In due course, the brand will be aligned with the company's core principles in the minds of the public with a positive impact on its reputation.

As more and more Mexican companies move into foreign markets, the cost pressures they will face to remain competitive may make it tempting to take ethical shortcuts. But, as I mentioned before, the need to safeguard the company's reputation far from headquarters is particularly strong and so implementing the ethical code in overseas operations is a cost that must be borne.

Companies should always try to make ethical standards universal throughout their global operations. However, sometimes local practices and laws make this impossible - as in the case of employing women in some Islamic countries. In these cases, companies must be completely open and transparent in explaining the variation in rules that cultural differences dictate.

In the end, it is up to individuals to embrace the values that result in an ethical corporation. People like to buy the products of ethical companies; investors like to buy their shares; suppliers like to do business with them; communities like to have them in their midst. All of these factors can lead to greater profits.

And, for the purpose of achieving the objectives of this conference, employees who subscribe to these codes are the sort of people to whom bribery is an obscenity.

Thank you.

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