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What are the Signs of Ethical Collapse in an Organization?

Reasons and Rationalizations for Unethical Conduct

Are there specific signs to look for of impending collapse of an organization? In her book The Seven Signs of Ethical Collapse, Marianne Jennings analyzes the indicators of possible ethical collapse in companies and provides advice how to avoid impending disaster.

Jennings starts with a description of ethical collapse, saying that it “occurs when any organization has drifted from the basic principles of right and wrong”, and she uses financial reporting standards and accounting rules as one area where this might occur. She points out that “not all companies that have drifted ethically have violated any laws”. Enron did not necessarily violate generally accepted accounting principles in treating the effects of some of its transactions with special-purpose entities off-balance-sheet. However, the company ignored conflicts of interest of Andy Fastow, the CFO, who managed some of the entities while wearing a second hat as CFO of Enron during the time the two entities had mutual dealings.

According to Jennings, “When an organization collapses ethically, it means that those in the organization have drifted into rationalizations and legalisms, and all for the purpose of getting the results they want and need at almost any cost.” A good example is Dennis Kozlowski at Tyco who misappropriated company resources for personal purposes without the approval of the board of directors and rationalized that he was just doing what those before him had done. Thus, he invoked one of the reasons and rationalizations for unethical behavior -- such an action is expected or standard practice in the organization.

Jennings links the rationalizations and legalisms to a culture that leads to behavior based on the notion “It’s not a question of should we do it”. It is a culture of “Can we do it legally?” This mentality occurs because of the combination of the seven factors working together to cloud judgment.

Jennings identifies seven common ethical signs of moral meltdowns in companies that have experienced ethical collapse. The common threads she found that make good people at companies do really dumb things include (1) pressure to maintain numbers; (2) fear and silence; (3) young ’uns and a bigger-than-life CEO (i.e., loyalty to the boss); (4) weak board of directors; (5) conflicts of interest overlooked or unaddressed; (6) innovation like no other company; and (7) goodness in some areas atones for evil in others.

In my studies of ethical failure, I have noticed four common failings in a variety of companies that suffered financial frauds. These are discussed below.

Pressure to Maintain the Numbers

It seems as though in many companies, tension exists between ethics and the bottom line. The first sign of a culture at risk for ethical collapse occurs when there is not just a focus on numbers and results, but an unreasonable and unrealistic obsession with meeting quantitative goals. This “financial results at all costs” approach was a common ethical problem at both Enron and WorldCom. At WorldCom, the mantra was that financial results had to improve in every quarter, and the shifting of operating expenses to capitalized costs was used to accomplish the goal regardless of the propriety of the accounting treatment. It was an “ends justifies means” culture that sanctioned wrongdoing in the name of earnings. Accountants like Betty Vinson got caught up in the culture and did not know how to be true to her values that such behavior was wrong.

Another example is Aaron Beam, the former CFO at HealthSouth, spent six months in jail because he couldn’t find a way to act on what he knew was the right thing to do and shut down the CEO of the company, Richard Scrushy, as soon as Scrushy started to demand accounting shenanigans to make the financial statements look better than they really were.

Fear of Reprisals

Fear and silence characterizes a culture where employees are reluctant to raise issues of ethical concern because they may be ignored, treated badly, transferred, or worse. It underlies the whistleblowing process in many organizations where ethical employees want to blow the whistle but fear reprisals, so they stay silent. One aspect of such a culture is a “kill the messenger syndrome”, whereby an employee brings bad news to higher-ups with the best intentions of having the organization correct the matter, but instead the messenger is treated as an outcast. Recent laws such as Sarbanes-Oxley and Dodd-Frank have built in long-needed-protections for whistle-blowers.

Loyalty to the Boss

Dennis Kozlowski, the dominant, larger-then-life CEO of Tyco, had an appetite for a lavish style of living. He surrounded himself with young people who were taken by his stature and would not question his actions. Kozlowski, who once spent $6,000 on a gold-laced shower curtain for an apartment paid for by the company, made sure these “young ’uns” received all the trappings of success so they would be reluctant to speak up when ethical and legal issues existed for fear of losing their expensive homes, boats, and cars and the prestige that comes along with financial success at a young age. They were selected by the CEO for their positions based on their inexperience, possible conflicts of interest, and unlikelihood to question the boss’s decisions.

Weak Board of Directors

A weak board of directors characterizes virtually all the companies with major accounting frauds in the early 2000s. At HealthSouth, Richard Scrushy surrounded himself with a weak board so that when he made decisions that contributed to an accounting scandal where the company’s earnings were falsely inflated by $1.4 billion, the board would go along, in part because of their interrelationships with Scrushy and HealthSouth that created conflicts of interest.

Ethical collapse is less likely to occur when top management acts on core values such as honesty, integrity, responsibility, and accountability. Ethical leadership is needed to ingrain such a culture into an organization. Absent the commitment to act in accordance with these values and lacking an ethical tone at the top, all too many companies lose their way and take the easy way out. Short-term decision making crowds out long-term ethical behavior and collapse may be just around the corner.

Blog posted by Steven Mintz on July 28, 2016. Dr. Mintz is Professor Emeritus from Cal Poly San Luis Obispo. He also blogs at www.ethicssage.com.

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