Interest in Corporate Ethics Is Still Weak

Ed Petry is to corporate America what the Maytag repairman is to washing machines. In this season of spectacular corporate breakdowns, the executive director of the Ethics Officer Assn. wishes he were busier.

Petry helped found the organization 10 years ago in the wake of the last round of corporate greed and misdeeds--the insider trading and defense contracting scandals. His group remains the nation’s only nonprofit, membership organization through which in-house corporate cops from all industries can help one another keep their companies toeing an ethical line.

The recent spate of corporate chicanery has given the association a bit of a boost. About 100 companies have joined in the six months since “Enron” became a crossword puzzle clue for scandal. The newcomers bring the membership to 805--still a small fraction of the more than 10,000 publicly traded U.S. companies and far fewer than what Petry would describe as a success.

“I wish more were calling,” Petry said from his office in suburban Boston. “My phone’s not ringing off the hook.”

That is one sign of what corporate watchdogs and ethics experts say is a reluctance within many executive suites to embrace the changes they believe are necessary to promote business integrity and restore the tarnished image of corporate America.

Corporate directors and executives don’t have to wait for new laws and regulations to implement many of the proposed reforms, such as rotating auditing firms, disclosing insider stock sales in advance and changing executive pay schemes. But there is little evidence that more than a few companies are making changes.

“Corporate America has been trying to slough this off and not make fundamental changes,” said USC business professor Ian Mitroff.

Although a few companies have said they plan to expand financial disclosures or add watchdog directors to boards, corporate governance experts said they don’t expect many firms to make serious changes for months, in part because many are poring over financial reports trying to figure out if they’ve got a problem of their own.

“Audit committees are looking deeper,” said Jeffrey Christian, founder of Christian & Timbers, an international executive recruiting firm.

Chief executives “are under intense scrutiny, not only from the [Securities and Exchange Commission] and from shareholders, but from the boards and even employees,” Christian said. “Employees are becoming whistle-blowers. They are feeling it’s more safe [now]. They’ve noticed things and put up with things that are not quite kosher, and they are going around the CEO to the board and having private, confidential meetings.”

Companies that have effective ethics programs, in which employees freely ask questions of and report problems to ethics officers, are less likely to uncover problems, said Petry of the Ethics Officer Assn. “If Enron, Arthur Andersen and Adelphia were members [of the organization], things might have been different.”

When the New York Stock Exchange was debating reforms to impose on member companies, it solicited Petry’s advice. The NYSE included five of Petry’s seven recommendations in rules proposed recently, including a mandate that all member companies have a code of ethics and vigorously enforce it by creating an internal reporting system that employees can use without fear of retribution.

Petry acknowledged that even the NYSE’s recommendations, which will be voted on by the NYSE board Aug. 1, may not be enough to force companies that don’t want to implement effective ethics programs. As it stands, he said, a majority of Fortune 500 companies have sub-par programs or none at all.

“Some companies will see [the NYSE proposals] as a wake-up call,” Petry said. “But there still will be many who take the easy way out. But if a company is hellbent on doing the minimum ... if they still don’t get it, then this isn’t going to convince them.”

Because of such attitudes, corporate watchdogs and governance experts said the success of the NYSE rules and a raft of other new and proposed reforms is anything but guaranteed.

“This is either going to be a time for a revitalization of the notion that ethics is not only good virtue, but it is essential for good business, or we will go further down the road of moral compromise where if it works, it’s right,” said Michael Josephson, founder of the Marina del Rey-based Josephson Institute of Ethics.

President Bush, who is scheduled to make a speech on corporate governance this week, is reportedly considering calling for mandatory jail time for corporate executives who falsify records. Josephson said that would be a step in the right direction.

“Businesspeople make cost-benefit calculations,” he said. “Whenever you can up the cost sufficiently, you really do reduce the likelihood of bad behavior. You don’t make them better people, but you do make them behave better. We have to make an example and deter them. If we don’t raise the stakes, things will just get worse.”

The idea of a corporate code of ethics was born in 1986, when many of the nation’s biggest defense contractors had become better known for kickback schemes and $980 toilets than for the development of revolutionary military technology. Facing the prospect of government regulation, 55 defense contractors agreed to develop an ethics code and install in-house ethics officers.

“The defense industry was given one last chance by the government to have voluntary efforts to fight waste, fraud and abuse,” Petry said.

At about the same time, the U.S. Sentencing Commission was developing guidelines on what judges should consider when weighing penalties for errant corporations. The guidelines, issued in 1991, instructed judges to consider corporate ethics programs as a mitigating factor in determining fines.

“The thinking is, if the company did everything we can expect a company to do, then it’s the bad apple that’s to blame, not the company,” Petry said.

“The fine reduction is significant,” he added. “If a company has an ethics program and cooperates with authorities, the fine is automatically reduced by 95%. If they don’t, it’s automatically increased by 400%.”

With such an incentive, companies outside the defense industry began hopping on the ethics-code bandwagon, and 12 corporate ethics officers, including Petry, formed the association to identify and promote effective models. But, he said, many companies adopted codes they believed would meet the sentencing guidelines--and then forgot about them.

“Those types of programs are still very commonplace and completely ineffective,” Petry said. “They are worse than nothing at all because they just fuel feelings that this is hypocritical. If you have a code but it’s never referred to and it’s not part of performance appraisals and no one is ever fired for breaking the code, then it’s quickly seen as not being serious.”

Some companies confused ethics programs with social-responsibility efforts such as using recycled products or sharing a portion of sales receipts with a charity, and have no actual internal integrity program. Other companies have compliance programs with hotlines to a lawyer’s office that “no one will ever call,” Petry said. “There’s a strong tendency against being a snitch.”

“Helplines” have been found to be more effective, he said. “It’s a subtle change in the name, but it’s a big change in philosophy. This is the number that you call when you aren’t sure, when you have questions. It’s a resource. It’s not answered by corporate lawyers. It’s answered by someone in the ethics office.”

To promote better corporate behavior, said Lawrence E. Mitchell, a corporate law professor at George Washington University and the author of “Corporate Irresponsibility,” reforms must target market-driven incentives for corporate executives to show profits at all costs, quarter after quarter--the kind of pressure that has been blamed for many of the examples of apparent corporate book-cooking.

Tax law changes and a shift in investor expectations over the last two decades have created a situation in which corporate officers focus almost exclusively on short-term goals, he said.

“As a consequence, what you see is corporations doing irresponsible things, like laying off lots of employees, which is a sure way for short-term returns and long-term trouble,” Mitchell said. “You see corporations cutting environmental corners, and you see corporations engaging in accounting shenanigans. The whole purpose, from Enron to WorldCom, is to make earnings look better than they are to keep share prices going up to benefit the executives and their stock options and to keep the market happy.”

Mitchell proposes raising the capital gains tax rate for shares sold within a short time from purchase--say within six months--creating an incentive for investors to hold on to stocks.

Another way to encourage executives to focus on longer-term goals would be to tie bonuses to multiyear corporate performance, said David Lewin, a business professor at UCLA’s Anderson School.

Lewin said he would require companies to report more information for investors to review, such as top-to-bottom compensation schemes, options awards and employee loans. As it stands, public companies are required only to report the annual compensation of their top five officers--a rule that has not changed since the Securities and Exchange Act was enacted in 1935.

“So investors have no way of knowing whether the CEO, [chief financial officer] or [chief operating officer] is making 10 times or 1,000 times what a front-line manager is making,” Lewin said. “That would be important to know because if investors don’t like how much the executives are paid, they will take their money out. There are ways, through relatively straightforward, modest improvements in financial accounting, that we could turn our eye on compensation and let the market decide.”

Corporate officers are at least starting to listen to ideas for change that they’ve rebuffed before, said Ira R. Kay, an executive compensation expert with consulting firm Watson Wyatt Worldwide. Kay is telling clients that it’s time to cut back on the number of stock options awarded to executives.

“The valid criticism of stock options is they do create excessive and fraudulent behavior because [executives] benefit in such a leveraged way from stock appreciation, with no downside,” Kay said. “This has been an issue for a decade, but, given the accounting favorability of options [for companies], nobody wanted to listen.”

In contrast, Kay said he got a call recently from a CEO of a company that pays executives “pure stock options, and they are very seriously exploring cutting back on their stock option plan.”