Consequences of Scandals Lack of Trust Investors’ trust in markets Public’s trust in corporations Employees’ trust in Leaders
Investors’ Trust in Markets Rest of Scandals Enron Breaks
Public Perception of Business Leaders ------------------ September 11, 2002
How Much do You Trust Large Corporations? Source: Hart-Teeter Poll
Has Honesty of Corporate Executives Changed in 10 Years? Source: NBC/WSJ Poll
Consequences of Scandals Lack of Trust Investors’ trust in markets Falling market and stock prices Public’s trust in corporations Increased call for regulation Employees’ trust in Leaders Lack of motivation/commitment
Discussion Questions: What were the causes behind these corporate scandals? How do you think firms can ensure that they are not the victims of such scandals? How can HR help?
Proposed Causes: Bad Apples (Individual personality/ethics/values) Dysfunctional Culture Dysfunctional Incentive Systems (Executive pay/stock options) Poor Controls The “System” (Analysts/Auditors/Shareholders)
Characteristics of Bad Apples What are some characteristics of leaders who are likely to end up in scandals? Lack of Moral Compass/Dishonesty Selfishness/Greed/Ego
Indicators of Bad Apples Lying –To Whom? – In reports – To peers/bosses/subordinates – To spouse?
Indicators of Bad Apples Excessive Focus on Money/Power/Self – Self-promotion over others – Credit history – Definitions of success – Treatment of subordinates
The Power of Culture How could Enron’s culture, which so many pointed to as its competitive advantage, result in its demise? How could Arthur Andersen’s culture, which was built on ethics, allow it to fall?
The Power of Values “Arthur Andersen did not lose its 50-year old reputation in a day. They sold their soul to their clients over the last 5-10 years by compromising their values more and more, just to make money. What looks from the outside like a giant step in destroying documents was to them just another step in sacrificing values for greed.” Unknown MBA Student
Where does the Culture get Off- Track Reward Systems begin to create dysfunctional incentives Controls begin to create dysfunctional incentives as well
Executive Pay What has caused executive pay to spiral, particularly relative to lower level employee pay? What have been the consequences?
Spiraling Executive Pay Total pay increased 2.2% in 2002, but… Executive pay increased 5.9% Middle Mgt pay increased 2.7% Rank and file pay increase 1.1% Company Revenues increased.89% Source: Economic Research Institute
What has Caused the Spiral? Market/War for Talent Unexpected stock gains Perceived Market (“above the mean”) Interlocking Boards
Potential Consequences Does executive pay (level of pay) focus leaders’ attention on the wrong things? – Does it drive ego? – Does it make people focus on pay more?
Executive Pay Dysfunction “The strange part is, the more I made, the more I got preoccupied with money. When suddenly I didn’t have to think about money as much, I found myself starting to think increasingly about it. Money corrupts the mind” Daniel Vasella, CEO, Novartis For the love of money is the root of all kinds of evil. I Timothy, 5:24
For the Love of Money… The oddest aspect of Kozlowski’s conduct, for those of us naïve enough to think that people take money because they somehow need it, is that he began availing himself of what became hundreds of millions of dollars in company loans…precisely at the moment that his pay was exploding… Kozlowski began regularly taking loans in 1996 and 1997 – just as his board-approved compensation leaped from $8.8 million to $52.8. It wasn’t until ’98 and ’99 though, that he really went hog- wild on the borrowing. Apparently his approved compensation of $136.1 million in 1999 left him in a cash squeeze. From “The Big Kozlowski”, Fortune, Nov. 18, 2002
Beyond Just Executive Pay Oh, and what about… – “spinning of IPO’s?” – Books? – Participation in other boards? Should outside pay of executives be controlled by the firm?
The System What responsibility to analysts have for the current crisis of trust? Focus on quarterly earnings Focus on meeting expectations Focus on growth Focus on consistent growth
The “System” Once you get under the domination of making the quarter – even unwittingly – you start to compromise in the gray areas of your business, that wide swath of terrain between the top and bottom lines Daniel Vasella, CEO Novartis Do not think lightly of evil, saying, “It will not come to me.” By the constant fall of water drops, a pitcher is filled; likewise, the unwise person, accumulating evil little by little, becomes full of evil Buddha, Dhammapada verse 121
The Wrong Controls or the Futility of Controls? We work in a system with certain safeguards, but they are imperfect. We can circumvent safeguards for our own interest and for our reputations short term or for short term success. Temptation is all around us… I do believe that the social framework in which we live gives us some boundaries and is absolutely needed. But all of these boundaries and all of the laws will be too weak and too imperfect to keep somebody on the right path who doesn’t want to walk on the right path. So if you want to cheat, you will always find a way. Daniel Vasella, CEO Novartis
The Course of Action It’s not about regulation; it’s about SELF regulation The only answer is diligence – Selecting Leaders with the right core values – Critically examining incentives – Constantly monitoring “real” culture – Building strong boards – Actively searching for conflicts – Focusing attention on the right things – Having the Courage to speak out
Be Courageous Know your moral values Be willing to stand up for them Be prepared to pay the cost “The tragedy of society is not the noisiness of the so-called bad people, but the appalling silence of the so-called good people.” –Martin Luther King Jr.