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«Global TrusT and EThics in FinancE Innovative Ideas from the Robin Cosgrove Prize Carol Cosgrove-Sacks / Paul H. Dembinski Editors Trust and Ethics in ...»

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The remuneration packages of finance industry executives, particularly Chief Executive Officers (CEO), have received increased criticism by the public. This potentially raises ethical questions and challenges for the finance industry.

A huge disparity has developed between boardroom remuneration and employee salaries. A recent study shows that 20 years ago, the average CEO of a publicly traded company made 42 times more than the average production worker. The same study shows the average present day CEO makes over 400 times the average employee’s income.

Whilst the statistics alone are alarming, there seems little justification for such remuneration packages when there is no compelling evidence that higher executive pay actually leads to better company performance. A study of 3000 companies found that the firms whose directors were the most well connected and that paid their CEOs most lavishly in fact underperformed the market (Surowiecki, 2007).

Not only does the finance industry need to determine what is an equitable allocation between shareholders, executive directors and employees, it also needs to consider ethical issues around various incentive structures and the apparent discretion of compensation committees.

100 Trust and Ethics in Finance There is also the issue of whether the pay of individuals and results of privately held companies should be reported. Many hedge fund managers argue that their pay should be kept private. They see coverage as sensationalist voyeurism driven by envy and titillation.

Currently there appears to be little alignment between remuneration packages and the sustainability and ethics of a company’s performance.

Other ethical challenges

Private equity and hedge funds are private pools of largely unregulated capital. They are removed from the controls of investment banks and often operate according to the lower standard regulatory regimes of the Channel Islands, Spain, Bermuda and Austria.

There are now calls for more transparency and particularly calls for disclosure of positions due to concerns about the risks hedge funds pose, annoyance about their actions and political expediency and lack of information about them.

Globalisation poses difficult ethical challenges for the finance industry. Implementing single ethical codes, value statements or compliance systems across the world invariably encounters problems when various laws and cultural differences are taken into account. It raises the question of whether a common set of company values is really possible for corporations that have operations in multiple jurisdictions.

Corruption remains an ethical challenge facing the finance industry.

It continues to affect both developed and undeveloped economies. A pressing problem is the corruption of regulators in developing countries and the subsequent exploitation of weak legal systems. As anticorruption rules have strengthened, forms of corruption, in developed economies in particular, are becoming increasingly subtle and sophisticated.

Ethics or Bust 101

The media as convenient scapegoat

The extent of the obligation of the finance industry to consider its social responsibilities and contribute to the societies in which they operate and impact is an ethical issue facing the finance industry.

The McKinsey Quarterly survey of 2006 found that the global business community had embraced the idea that it should play a wider role in society. More than four out of five respondents agreed that generating higher returns for investors should be accompanied by broader contributions to the public good, for example by providing good jobs, making philanthropic donations and going beyond legal requirements to minimise pollution and other negative effects of business.

As the finance industry attempts to gain the confidence and trust of the public, the relationship between the industry and the media will present ethical challenges.

With the much-publicised ethical lapses of the last ten years, public scrutiny, particularly by the media, has increased. Consequently the relationship between the finance industry and the media is now strained.

More recently the finance industry has claimed that it is presented in a bad light by the media and suffers from overzealous reporting.

A report conducted by KPMG found that Australian Boards are concerned at their inability to reassure the news media, and through it the public, of their concern to promote and safeguard ethical business standards. The report concludes that the media is a convenient scapegoat, but not necessarily a convincing one.

The finance industry will continue to be affected by the influence of the media and this is only likely to increase with projects such as Wikileaks where an uncensorable Wikipedia is being developed for untraceable mass document leaking and analysis.

The persuasive business case for an increased emphasis on ethical considerations in and by the finance industry should be sufficient: ethical lapses can and often do lead to major profit losses and companies 102 Trust and Ethics in Finance can cease to operate as a result. Damage to reputation and confidence loss is hard to measure and difficult to recover from. Scandals such as that of the National Australia Bank invariably taint the whole industry and the corporate sector. It is therefore in the interest of the whole corporate sector that the ethical issues facing the finance industry are addressed.





Whilst ethical codes, value statements, risk management programmes and reputation indexes have become more prevalent, the ethical performance of the finance industry is hard to measure and therefore is likely to continue to trouble and struggle to gain traction in an industry that is accustomed to definite and quantitative rather than qualitative outcomes. There are however structural improvements and educational initiatives that the industry can implement in order to bring about real change to the ethical performance and culture of the finance industry.

Finance industry: Beyond compliance and good marketing

For ethics to catalyse and enliven the finance industry – essentially, for ethics to become a living concept – the industry must move beyond viewing ethics as a matter for compliance and good marketing. Ethical thinking and an ethical way of life need to be woven into corporate culture and thus the day-to-day business of the finance industry.

All initiatives must be endorsed by senior management, including the Board and the CEO, and attendance ought to be compulsory. Responsibility, ownership and communication of any initiatives should reside with Senior Management rather than Human Resources or Compliance.

The finance industry should further consider funding the establishment of an independent Ethics Body to initially have the following responsibilities:

• provide ethics specialists to sit on and advise Boards;

• conduct situational and annual reviews of organisations ethical conduct and make recommendations;

Ethics or Bust 103

• work with regulators to keep up with developments in the industry;

• facilitate focus groups and evaluation of the way financial institutions do business in new and developing markets; and

• facilitate the sharing of information and experiences between organisations so that organisations can learn from each other rather than managing issues away through clever public relations and payouts.

Ethical conduct should be a key performance indicator along with other standard indicators such as profit generation and business development. It must apply to Board members, CEOs, Senior Management and all staff. Ethical performance should then be linked to salary determination, bonus allocations and other performance incentives that are common to the finance industry.

This proposal will require a complete reorganisation of current incentive structures such as deferred compensation. If unethical behaviour is detected after an individual has left an organisation or division, future payments due to them should not be made without consideration of the individual’s role in any unethical or fraudulent business that has been uncovered. Additionally, money already paid to an individual should be retractable following the discovery of unethical or fraudulent business practices.

Extending the accountability of executives beyond their narrowly defined term of employment would serve to curb the practice in the finance industry whereby individuals make vast amounts of money, without regard for the way in which such profits are achieved, and then leave an organisation before unethical or fraudulent practices are discovered or regulatory action is taken.

Rewarding good ethical behaviour Whilst this proposal will require much legal re-drafting, possible legislative changes to employment laws and financial analysis, it would unTrust and Ethics in Finance doubtedly serve to increase executive’s ethical accountability and thus the ethical conduct of the finance industry.

Society is comfortable with imposing financial sanctions, such as fines and operating restrictions upon organisations and individuals for unethical and fraudulent behaviour. Whilst financial punishments for unethical behaviour should be maintained, this system needs to be complimented by a system of rewards. As well as punishing people for poor ethical performance by withholding bonuses or performance pay, organisations should move to a system of financially rewarding good ethical behaviour.

Of course, some will debate the ethics of providing financial incentives for people to behave ethically. Others will consider the difficulty in actually determining and quantifying ethical behaviour as insurmountable.

Ideally, acceptable ethical behaviour would be a natural part of business life and society would not require either a punishment or a reward system. However, the reality is that unethical behaviour has plagued and continues to plague the finance industry, thus proving that relying on the goodwill of individuals alone to recognise and promote right conduct or a system of punishment is not enough. What should drive development in this area is the likely eventuality of increased ethical consideration in business as the finance industry and its participants are unarguably motivated by financial incentives.

Appointment of ethics role models

Organisations should identify and appoint staff to hold the position of Ethics Role Model in addition to their existing business function. Ethics role models should come from all areas of an organisation, particularly profit centres, as well as support areas.

Criteria for selecting ethics role models should be based on their reputation for sound ethical judgement, integrity and trust. These indiEthics or Bust 105 viduals should be encouraged and rewarded by senior management and empowered to play a more active role in the development of an ethical work culture within the organisation.

Ethics role models should be promoted as champions of ethics in the organisation and be available to staff as a point of contact to discuss the ethical dimension of business life. They should also be encouraged to take a proactive, educative role and encourage ethical networks within and outside an organisation. These positions should be considered prestigious and this will only come from Senior Management endorsement and encouragement.

Accountability at the point of innovation and deal-making

The finance industry is complex to the point that regulators, compliance and lawyers do not necessarily understand all, or many, aspects of the transactions and deals that they are subsequently required to sign-off, monitor and regulate.

In order to address this issue the finance industry needs to rethink the structure and responsibilities of their business, compliance and legal teams. Responsibility for the ethical aspect of a deal or innovation must be left to the individuals who understand the deal or innovation.

Rather than, or at least in addition to, deal-makers and innovators seeking sign-off from legal or compliance, legal and compliance teams should require acknowledgement from the innovators and deal-makers that they have considered the ethical dimension of the way they are doing business, including the current impact and the future impact of a deal or product. Additionally, board papers should include a section on ethical implications as well as financial and risk analysis.

The best time for organisations to first impress upon staff that the ethical aspect of business is important to them is at the point of induction.

106 Trust and Ethics in Finance CEOs and senior management should play an active role in induction programmes by personally attending and detailing how they expect staff to do business, as well as providing examples of what can and has happened when people have behaved inappropriately. It should be clear to inductees what is expected of them and what is acceptable business practice.

The induction process is of particular importance in developing countries and markets.

Tool for engagement and collection

For an organisation to make positive progress in the area of ethics, it must understand its current ethical climate and culture. It is imperative for an organisation to know what its’ staff thinks about ethics, how they define it and what they perceive as the ethical challenges facing them and the organisation. Collecting such information and analysing the responses will assist an organisation in designing and implementing effective programmes and strategies.

Factors that individual organisations will need to consider when developing an engagement and collection tool are:

• Time: Executives have many competing interests with their main focus being their business role. Training is often viewed as taking them away from their real work. Considering this mindset any collection tool should be designed to be completed in 1 hour or less and executives given a realistic, yet tight, timeframe for completion.

• Delivery: Organisations should determine what delivery method best suits them. For a large global organisation an electronic collection tool may be the most effective. Other organisations could consider using simple hardcopy surveys, conducting focus groups or phone surveys. Factors such as organisation size, location and budget will affect the choices in this area.

Ethics or Bust 107

• Culture: any material will need to take into account cultural factors such as language, office location and religious beliefs. The more tailored the programme is, the more engaged the participants will be.

• Communication: Ideally a collection and engagement tool would use a variety of mediums including film, voice-overs, text and animation. Most organisations now have staff from at least three generations, all of whom have different methods of processing information. By using a variety of media an organisation has a better chance of reaching more staff.

• Compulsory: Completion of the engagement and collection tool should be compulsory for all staff, including senior management, with failure to participate attracting financial consequences.

After an organisation has determined its ethical starting position, the next step is to conduct meaningful workshops based on the content collected from the engagement and collection tool.

Workshops should provide a forum to discuss real ethical dilemmas.

Attendees should be given the opportunity to anonymously submit topics or issues for discussion prior to attending. This gives individuals another avenue for raising issues that may be of concern to them and removes the pressure and hesitation of raising such issues in front of peers or superiors.

The process of engagement and collection followed by workshops can be repeated constantly in order to monitor progress and developments and to reach staff throughout their careers and time with an organisation.

As for the CEO and representatives of Senior Management, they should host ethical discussion lunches. Eight to twelve employees should be chosen randomly from across the organisation and invited to attend. This is an opportunity for Senior Management to open themselves to honest discussion and questions on ethical issues.



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