Business & Professional Ethics
MMPA Program, 2003
Prof. L.J. Brooks
Rotman School of Management
University of Toronto
Corporate Policy & Practice

What principles do you
associate with your firm in
business dealings?


Do whatever it takes?...
Does your firm:




have an ethics code and an ethics
officer?
encourage whistleblowers?
try to manage its reputation?
try to manage its ethics risks
globally?
Consequences

Corporate Scandals




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Enron, WorldCom, Global Crossing,
Tyco, Adelphia, Haliburton, ImClone,
Xerox, …
Employees
Customers
Loss of reputation
Reform of Governance and
Accounting
The Enron Affair

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Management was:
 out of control, and engaged in selfdealing
 manipulating transactions & financial
reports
Company imploded - Chap. 11 in Dec./01
Investors misled, pensions lost
Executives plead the 5th, poor memory,
ignorance, incompetence
Outrage
Auditor savaged, profession to be changed
Enron Stock Chart
Weekly Prices 1997- 2002
Source: www.globe investor.com
Enron’s Business


Transportation and distribution
Wholesale services


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Commodity sales & services, risk
management products, plants, etc
Retail energy services - gas,
electricity
Broadband services


(10K-2000)
Nationwide fiber-optic network - build,
market, etc.
Corporate and other

operation of water, renewable energy,
and clean fuels plants plus other
corporate activities
Enron’s Income (IBIT):
Income Before Interest, Minority Interest and Income Taxes
2000
1999
Transport & distribution ($ mil.)
Trans. Services
391
380
Portland General
341
305
Wholesale Services
2,260 1,317
Retail Energy Services
165
(68)
Broadband Services
(60)
Exploration & prod.
65
Corporate and other
(615)
(4)
IBIT
2,482 1,995
1998
351
286
968
(119)
128
(32)
1,582
Enron’s Wholesale Services


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…creation of networks involving selective
asset ownership, contractual access to thirdparty assets and market-making activities.
10K p.36.
…uses portfolio and risk management
disciplines, including offsetting or hedging
transactions, to manage exposures to
market price movements (commodities,
interest rates, foreign currencies & equities).
10K p.37.
… sells interests in certain investments &
other assets to improve liquidity & overall
return,
10K p.37
Enron’s Financial Data
Revenues
(in Billions)
Operating income
(Millions)
IBIT
Net Income before Cumulative
Accounting Changes
Net Income
EPS (in dollars)
- basic
- diluted
2000 1999
100.8 40.1
1998
31.3
1,953
802
2,482 1,995
1,378
1,582
979
979
1,024
893
703
703
1.22
1.12
1.17
1.10
1.07
1.01
Enron’s Financial Data
2000 1999
Current assets
(Billions)
Investments, other
Property, plant, equip, net
Total Assets
30.4
23.4
11.7
65.5
7.3
15.4
10.7
33.4
Current liabilities
Long-term Debt
Deferred credits and other
Shareholders’ Equity
Total Liab. & Shareholders’ Equity
28.4
8.6
13.8
11.5
65.5
6.8
7.2
6.5
9.6
33.4
Enron’s Changing Risk Profile
Early
1990’s
By
2000
Risk
Level
Pipelines, distribution networks
Retail energy
Power generation



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Low
Low
Low
Oil and gas exploration
Alternative energy



Med.
M/H
Hedging transactions
Commodity trading transactions
Broadband optical fiber networks



High
High
V. High
Related party transact. (SPEs/Partnerships)

???
Corporate Governance
Role of the Board of Directors - traditional
 strategic objectives - set or approve
 appoint CEO, approve other officers
 company policies and procedures:



set or approve
ensure dissemination and compliance
laws, regulations, & expectations of society


ensure monitoring and compliance
act as ethical conscience (Dey Report & CICA)
Corporate Governance
Role of the Board of Directors
 “to supervise, direct or oversee”…”day-to-day
management must be delegated to others”
Dey Report (1994)

5 core functions (CICA/TSE, 2001):


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Choosing the CEO and ensuring the team is sound
Setting the broad parameters the management team
operates within
Coaching the CEO and team
Monitoring and assessing the performance of the CEO,
setting the CEO’s compensation, approving the team’s
Providing assurance to shareholders and stakeholders
about the integrity of the corporation’s financial
performance, incl. Quarterly Reports.
Corporate Governance
Audit Committee must:
(CICA/TSE, 2001)
 Provide assurance that external auditors are:
 independent
 satisfied accounting estimates & judgments
are sound & in accord with GAAP
 Develop sufficient rapport with external and
internal auditors, and management to
facilitate
 Approve mandate of internal audit group, and
ensure it has adequate resources to ensure an
effective internal control framework & culture
 Disclose mandate
Enron’s Governance Failure Begins

1997 - Board suspends code of conduct to
deal with an SPE (JEDI/Chewco) emergency:
 Can’t find outside investor before year-end
 Non-consolidation tests not satisfied:

Outside investor


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3%investment at risk
Control of decisions
Fastow (CFO) has Koppers - who reports to
Fastow - appointed to run/invest/control SPE
No follow up on alternative controls
Now that guard is down/can be controlled
Enron’s Governance Structure
© L. Brooks
Outside Law Firm
Finan.
SPEs
Reports
Board
Ken Lay: Chair; Co-chair ZZZ
Audit, Compensation Cees.
Guidance
Missing
Suspended
Management
Compliance
Company
Lay, Skilling: CEO
Policies
Fastow, CFO; Koppers
Code of Conduct
Causey, CAO; Buy, CRO
Watkins; Kaminsky; McMahon
Auditor
Internal Audit ?
Arthur
Whistleblowers ?
Andersen
Consultant: Arthur Andersen
Governance Failure Allows

Fastow to control SPE transactions:

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Sales of assets at inflated prices (False
gains)
False hedging of losses on Enron
investments (Falsely keeps losses off
Enron Income Statement)
Exorbitant payments to Fastow & helpers
Hiding of SPE debt ultimately to be borne
by Enron
Fastow to create more SPEs (LJMs…)
Manipulation of accounting disclosure
Partial Impact
Payments to Fastow & helpers
Fastow
Invest._ Return
$25,000 $4.5 mil in 2 mo.
Koppers 125,000
2 others
10 mil (incl.
friend)
5,800 1 mil
Other
$30 mil+stock
options+
$2 mil in fees
Manipulated transactions in Q3 & Q4, 1999
Asset sales, plus 1 hedge contribute
$229 profit of $570 before tax/$549 after tax ~50%
Control Benchmarks

General presumption regarding
control


Normally – equity ownership >50% must also prove control exists
SPE – U.S. equity investment (at risk)
>3% (proposed 10%), Canada
>10%(in certain situations) - must also
prove control exists
SPE benchmark lower due to uniqueness of SPE
Chewco/JEDI
Kopper/Dodson
Dodson
LP/GP
Big/Little
River
SONR
$11.4
GP
LP
$11.4
ENRON
GP
$240 + $11 +132 = $383
© I. Wiecek
Chewco
$132
LP
JEDI
$240
Barclays
Select Enron SPEs
Purpose
Issues
Chewco/JEDI
Syndicated
investment
Off balance sheet
liabilities ($628
million), revenues
recognized early
LJM
Provided market
for assets
Artificial profits
Equity overstated
($1.2 billion)
LJM1/Rhythms
LJM2/Raptors
Investment
“hedge”
Unrecognized
losses
Investment
“hedge”
Unexpected losses
$508 mill. ‘97-’00
$544 mill.
Enron’s Governance Structure
Was Short Circuited
© L. Brooks
Outside Law Firm
Finan.
SPEs
Reports
Board
Ken Lay: Chair; Co-chair ZZZ
Audit, Compensation Cees.
Guidance
Missing
Suspended
Management
Compliance
Company
Lay, Skilling: CEO
Policies
Fastow, CFO; Koppers
Code of Conduct
Causey, CAO; Buy, CRO
Watkins; Kaminsky; McMahon
Auditor
Internal Audit ?
Arthur
Whistleblowers ?
Andersen
Consultant: Arthur Andersen
Enron’s Ethical Culture


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Code suspended, alternate controls ignored
Bogus trading floor for visiting analysts
California energy market manipulation
Whistleblowers/doubters came forward (to), but
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Co-chair (Lay) resigned, 32 mil. … suicide?
Kaminsky (Fastow) …….. ignored
McMahon (Fastow)...transferred …now CEO
Sharon Watkins (Lay)… Enron’s law firm
found no problem …fox in the chicken coup
No protected whistleblower path to the Board
Do we need an Ethics Committee?
New Board Responsibilities
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Comprehensive Risk Management
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Broad understanding of business model
Financial literacy
Guidance & Control framework
Focus on corp. culture, ethics & reputation
Business ethics…whistleblower protection plan
Ethics Risk Management
Trust, but challenge, don’t turn away

Caremark National Case, trend
© L. Brooks
Comprehensive Risk Management
requires
understanding the business
Risk Events Causing Drops of Over 25% Share
Value,
Percentage of Fortune 1000 companies, 19931998
Strategic ……………………………. 58%
Customer demand shortfall (24)
Competitive
pressure (12)
M & A Integration problems (7)Mis-aligned products (6)
Operational …………….31%
Cost overruns (11)
Accounting
irregularities (7)
Management ineffectiveness (7)
Supply chain
pressures (6)
Financial ………..6% [Foreign macro-eco, interest rates ]
Hazard …….0%
[Lawsuits, natural
Comprehensive Risk Management
includes Ethics Risk Management
Ethics Risk
Reputation
Success
Reputation is important
 Arthur Andersen……………
survival
 RT Capital…………reputational
capital
 Tylenol ……………competitive
© L. Brooks
advantage
Comprehensive Risk Management
depends upon the Corporate Ethical Culture

Comprehensive Risk Management utilizes
both:
A. Key risk factor identification & measurement
B. Review of key business processes including the
ethical culture that underpins process integrity

Ethical culture provides guidance for
employees about when to adhere to the Code,
when actions are not covered in Code, in a
grey area, or in a crisis - tools to measure
ethical culture do exist
Enron’s Board failed to consider any of this!
Few corporations do A, fewer do B!
© L. Brooks
Audit Committee must
Understand key business
operations
 Understand comprehensive risk
management model and reports
 Examine key/large transactions
 Ensure compliance with good
policies
 Ensure fair presentation
Who wants this risk?
© L. Brooks How much should the members be

New Governance Issues
For directors and senior
officers:

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Director’s Responsibilities
Financial literacy
Guidance and control systems
Ethics risk management
Comprehensive risk
management
How important is reputation,
public interest,…
Emerging Risk-oriented Decision
Criteria for Directors
Criteria (New)
Interests/Risks Considered

Profitability & legality …… Shareholders +

Fairness & rights …… Specific Stakeholders

Expectations Gap ………. the Public Interest
Overview of Key Problems
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Governance failure at the Board level
 Too much trust
 Incompetence - awareness and/or
understanding of role , control & reporting
systems
 Lack of motivation, conflicts of interest
Dishonest management, conflicts of interest
Culture of deception, self-interest
Manipulation of accounting and disclosure
Poor standard setting
Auditor deficiencies
Regulatory short-sightedness
Ethics Means...


What is right or wrong?
What/who determines?
 Societal


values
 Individual values
 Religious beliefs
Lots of interpretation possible
Stakeholder perspective
A Stakeholder Is...

Anyone who is affected by or can affect the
objectives of the organization
(Freeman, 1984)
 Anyone who has something at risk as a
result of a activity of the organization
(Clarkson, 1995)
 An organization must have
the support of its primary stakeholders,
to optimally achieve its strategic objectives
Success is Changing
Stakeholders are Very Important
CEO’s Views on Top Challenges in
2000
1. Recruiting skilled staff
2. Pressures from stakeholders
3. Environmental demands
Source: Smy, 1999
Accountability...

To stakeholders, not just
shareholders:



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Capital markets...
Consumers…also Nike…supplier codes
Employees...
Environmentalists...
Global, immediate info flow
Lingering liability
Increasing sensitivity, morality
Success/Wealth Creation Depends On

Relationships with Stakeholders

Relationships depend upon:


Reputation and
Values or hypernorms for most cultures
Reputation

Corporate reputation …
the overall estimation in which the
company is held by its constituents –
customers, investors, employees, and
the general public to the company’s
name.
Fombrun, Charles J., Reputation: Realizing Value from
the Corporate Image, Harvard University Press,
Boston, Mass., 1996, p.38
Tragic Loss of Reputational Capital
Exxon


14 trading days after Valdez Oil Spill,
3/24/89
$3 billion approx. lost on $57.64 billion
J&J



After the Tylenol tampering, 9/30/82
$1.13 billion lost on $8.262 billion
In 1986, $1 billion lost on $9.1 billion
What makes a good reputation?
Credibility
Reliability
Corporate
Reputation
Trustworthiness
Responsibility
Formbrun, p. 72
What Does Success Depend on?
Support from Stakeholders
where
Long-term Success = f(Trust +
Respect)
Values:
Honesty, Fairness, Compassion,
Integrity, Predictability,
Responsibility
Business Ethics...
…the moral standards that apply to
business policies, institutions and
business behaviour.
 Dealing
with stakeholders
Identifying who, interests,
priority
 Corporate social contract
 Stakeholder impact analysis

Global Ethical Developments
North American
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European

Pollution, gender...

FCPA- bribes
Sentencing

Guidelines

Disasters
Caremark National 
Activist stakeholders 

Media
Supplier codes
Whistleblower Prot.
Environment
Embarrassment

Bribes, OECD
Disasters
Overall performance
Public reporting
Media
CSR Reporting
Crises Of Confidence

Financial scandals





Enron, WorldCom, Global Crossing,
ImClone, …
Philip Services, YBM, Livent, Cendant
Bre-X
Barings Bank, R.T. Capital
Bizarre decisions


Bank mergers
Bank downsizing when profits are high
GE Whistleblower






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Boss & bosses’ boss overcharging Israel
for jet fighter engines
Gathered evidence for 4 years
Sued for $70 million - False Claims Act
US Government took case over
Whistleblower can get up to 25%
Settled for $59.5 + $9.5 mil.
How much would you give W/B? Why?
Governance

Legitimacy of non-shareholder interests:






US Sentencing Guidelines - 1991
TSE - Report on Corp. Governance - 1994
 Directors responsible for corporate ethical
culture
CICA - Criteria for Control Guidelines - 1995
 Ethical culture is essential for internal control
Caremark National Inc. - 1996............US
 Need to look for problems and rectify, not sit
back
Section 201B (US), CBCA Rev?..may consider
Reform

Sarbanes-Oxley Act, 2002
Ethical Corporate Culture
Sound governance is based on shared ethical
values & ethical decision making:
 Values will determine attitudes &
behaviour
 Values are shaped & supported by an
organization’s culture
What Board of Directors and/or
stakeholder group can afford external
whistle blowing/or ethical slips?
1999 Conference Board Report


Rapid increase in formulation, implementation
and monitoring of BE practice standards
Consensus on key corporate values:



Global business practices need fixed reference
points
Ethical decision-making procedures allow managers
to act in accord with core, identifying company
values
Ethical decision-making requires an employment
environment of trust, free from reprisals for
employee decisions and actions taken in good faith
Business Ethics Value Chain
CORPORATION
Governance
Mechanism
Formulation
of Strategic
Objectives
STAKEHOLDER
SCREEN
ACHEIVEMENT OF
STRATEGIC OBJECTIVES
Customers
INFLUENCES
Employees
ACTIONS
Primary
Capital Markets
Current:
Shareholders
Lenders
Environmentalists
Other
BEHAVIOUR Host Communities
Governments
NGOs
GO
CAUTION
STOP
DETERMINANTS OF VALUE…Success = f(Trust + Respect)
CORPORATE CULTURE
ETHICS PROGRAM &CODE
TOP MANAGEMENT SUPPORT
STAKEHOLDER SYNERGIES
CHARACTER
GLOBAL MEDIA
PERCEPTION OF:
TRUST
RESPECT
RELATIVE IMPACT
RELATIVE SALIENCE
LOCAL CULTURE
The Clarkson Principles
Ethical performance should be managed
to maintain support of the
stakeholders by
Principles of Stakeholder Management
Acknowledge & monitor concerns
 Listen & communicate
 Adopt sensitive processes and behaviour
 Recognize interdependence
 Work cooperatively
Avoid jeopardizing inalienable human rights
 Acknowledge potential conflicts


Stakeholder Impact Analysis
CHALLENGES FOR
PROPOSED ACTION:
 Profitable?
 Legal?
 Fair?
 Right?
 Sustainable?
TYPICAL FLAWS
ENCOUNTERED:
 Short run
 Only test?
 To all?
 Personal+
 Optional
 No modification
Reputation Management
A New Stakeholder-Based Model
Competitive
Advantage
Top
Management
Values
Strategic
Plan
Organizational
Processes
Identity
Reputation
__Stakeholder Screen__
Values__
Principles
Emotion
Honesty
Fairness
Compassion
Integrity
Predictability
Responsibility
Trustworthiness Trust
Media
Image
Credibility
Reliability
Responsibility
Respect
Image
Management
Corporate Citizenship Options
Chris Marsden, Business & Society Review, Spring 2000, Vol. 105:1, 9-25, Table p. 17.
Corporate
Citizenship
Company
Objectives
Denial
Reactive
Engagement
Pro-active
Engagement
7
8
Reactive Holistic
Engagement
Impact assessment, Risk analysis
Stakeholder partnership building
‘Hard reporting’
5
Reactive Partial
Engagement
ISO 14001
SA 8000
Policy statements
‘Soft reporting’
2
Specialist Reporting
To CEO
% club, Co. Foundations
9
Active Sustainability
Leadership
Triple bottom line accountability and
audit, integrated management
systems
6
Pro-active Partial
Engagement
Stakeholder
partnership building
Pioneering new code of
conduct or monitoring system
3
Specialist Intervention in Societal
issues
Strategic Philanthropy
Triple Bottom Line
Environmental
Social
Financial
Shareholder Value
Managerial
Satisficing
4
Devolved External
Affairs
PR/sponsorship
Local community
investment
1
Discretionary
Philanthropy
Chairman’s wife
Implications for Accountants

For next day...