Culture: The Key to Corporate Governance

Written by Carl Anderson

It seems that not a year goes by without some sort of major financial scandal unfolding. Whether it be Enron or Bear Stearns, subprime mortgages or Libor, illicit currency trading or Bernie Madoff, an observer could easily come away with the impression that bending the rules of ethical behavior is the norm in business. In reading about scandal after scandal, it almost always seems that governance—either top-down enforced compliance or employee self-policing (and sometimes both)—is lacking.

The result is an endless game of cat and mouse, where government passes stricter regulations to plug loopholes exploited in the last crisis, and employees at major corporations find new loopholes to exploit or even ignore regulation altogether.

The fault, we might say, ultimately lies not in our laws, but in ourselves. No amount of retrospective regulation will ever stop the next scandal, because it is the ethical framework in which individuals operate that ultimately decides the qualitative nature of the actions taken. The same is true for corporate governance. A code of ethics is a good start, but without having the hearts and minds of a company’s executives and employees on board, it is probably not enough.

Solving this quandary is a governance issue that has to go beyond stated policy. It has to be lived. Peter Drucker’s famous quip that culture eats strategy is a familiar refrain, and with good reason. It’s true, and that statement has particular truth if applied to corporate governance.

If governance is seen merely as a strategy, it will never overcome the culture in which it is situated. Quite simply, corporate governance is as much about what is done, tolerated, not tolerated, rewarded, and lived—especially by the organization’s leaders—as it is about what is written into a code of ethics or espoused on paper somewhere. If the daily lives of corporate leaders are divorced from the governance ideals they espouse, the odds of successful governance are seriously reduced.

Corporate governance shapes the culture as much or more by what it does than by what it says. Over time, with leadership that lives out the ideals espoused, culture begins to self-regulate, governing behavior in a way that accentuates what fits while rejecting what does not.

Of course, this can be positive or negative, depending on what culture emerges. But whether a culture develops in which profits are the result of excellence or one develops that pushes ethics aside in a relentless pursuit of profits, one will be able to learn much about the power of culture and the power of corporate leadership from the top down.

This is not to say that aberrations will never occur, but such aberrations, acted upon quickly through strong corporate governance, will be rooted out by the employees themselves—in concert with a robust compliance operation—long before they can rise to the level of tainting the entire culture.

Rather than solving each problem retrospectively, ideal corporate governance ultimately shapes its culture, building on what is good and discouraging what is not. It is a commitment that begins at the top and quickly becomes part of the culture as its ideals are consistently expected and applied at every level, from the board of directors to the mail room. It provides a moral compass that can be applied to any situation, rather than simply a set of rules for isolated instances.

Empirically, this works well not just for the culture, but for the bottom line. Corporate culture is best, and most successful, if it puts another value above profit, as Jim Collins and Jerry Porras persuasively argued in their book Built to Last: Successful Habits of Visionary Companies.

They studied some of the largest and most successful companies in American history to determine how some thrive for decades while their closest competitors collapse, and among their most important findings was that the most successful companies do not exist first and foremost to maximize profits. “They seek profits, but they’re equally guided by … core values and a sense of purpose beyond just money making.” As a result, Collins and Porras found that these companies “make more money than the more purely profit-driven comparison companies.” In the end, perhaps the easiest way to conceptualize the common denominator of successful “built to last” companies was that they in some way put people before profits.

Not surprisingly, the father of market economics, Adam Smith, was a moral philosopher. Before he wrote The Wealth of Nations, he authored The Theory of Moral Sentiments, in which he extolled virtue and went so far as to say that “virtue” in nearly every instance was “the surest way to obtain safety and advantage.” One could easily argue that for Smith, self-interest was inseparable from virtue, and thus a character like the fictional Gordon Gekko would represent a terribly warped understanding of Adam Smith’s economics.

A culture that views “stakeholders,” “customers,” and others in an abstract and impersonal way is not a culture that is connected to the real human dimension upon which every company ultimately must depend. How people within that company deal with one another and with those outside the company tells the greater part of the story of a company’s values.

A company whose culture looks at the world with a sense of fraternity and a purpose that seeks widely defined improvement will have very different sets of priorities, values and acceptable behaviors than a company interested only in maximizing profits, whatever the cost.

A first step in this direction is to encourage, reward and live out at work the same ethical standards one has at home. In his classic book Management: Tasks, Responsibilities, Practices, Drucker writes of the abysmal state of “business ethics” when divorced from personal ethics:

“Businessmen, we are told solemnly, should not cheat, steal, lie, bribe, or take bribes. But nor should anyone else. Men and women do not acquire exemption from ordinary rules of personal behavior because of their work or job. Nor, however, do they cease to be human beings when appointed vice president, city manager, or college dean. And there has always been a number of people who cheat, steal, lie, bribe or take bribes. The problem is one of moral values and moral education, of the individual, the family, of the school. But neither is there a separate ethics of business, nor is one needed…..”

[1]

In this, Drucker is certainly correct. Encouraging the practice of ethical behavior based on the ethics of daily life in employees’ and executives’ relationships with family and friends is both easy to understand and effective. The idea that unethical actions that should be avoided at home should likewise be avoided at the office is a simple but powerful first step toward governance that encourages and builds ethics. And, as with all things on this topic, it must not be imposed from the top down, but lived from the top down.

Drucker goes on to say, “All that is needed is to mete out stiff punishments to those—whether business executives or others—who yield to temptation.” Not tolerating unethical behavior is certainly part of the solution, but it has its limits as a standalone strategy because it is inherently retrospective. It must be one tool among many—the most important of which is first setting a comprehensive ethical course that puts values and people above the quest for profit and then guides every decision—with executives leading the way by their own example in this regard. And once the culture of a company becomes ethical, things begin to come full circle, and the culture begins to feed the strategy rather than eat it.

[1] Peter F Drucker, Management: Tasks, Responsibilities, Practices.63-64