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In a series of articles in Business Life and a new book, All You Need To Know About Ethics and Finance, Avinash Persaud (left), chairman of Intelligence Capital Limited, and FT columnist John Plender (right) examine the issues and pressures faced by all in business and finance.

IMr Persaud and Mr Plender answer readers’ questions.

What role do regulators have in enforcing corporate ethics?
Neil Courtis, London, UK

John Plender: Regulators set the rules and create a climate. But our book argues that you cannot regulate people into good behaviour; and much of the focus of business ethics is about how to address dilemmas where there are no laws or specific regulations to provide guidance. As the earlier answers imply, we think that excessive regulation carries the risk of encouraging a compliance culture instead of an ethical culture.

The biggest failure of the lawmakers and regulators since the rash of corporate scandals is that they have inadequately addressed the flawed incentive structure - the carrots and sticks, in simple terms - of the Anglo-American capital market system. The thrust of the US policy response, most notably in the Sarbanes-Oxley Act, has been largely about sticks rather than carrots. Clearly penalties are needed for bad behaviour. But it is the carrot of stock price related rewards in the boardroom that is at the root of most of the corporate scandals.

Avinash Persaud: This is an important question. We believe that there are many things that are unethical that ought to be illegal (and often after a crisis, they become so). Regulators have a role to play in this area. But there are also many things which are not illegal, but are unethical. Many of the things that went on at Enron were not illegal, but were unethical.

When Darleen Druyun asked Boeing to give her daughter and son-in-law a job at Boeing while she was considering awarding them a $4bn contract, it was not technically illegal, but it was unethical. In these cases, we can probably write tighter and tighter codes for regulators to enforce, requiring the unethical to be more and more innovative, but we need to reply upon individual ethical responsibility and if we are going to rely upon it, we should ensure that we reward good ethical behaviour and not punish it when it comes to promotions and compensation.

When I was at the old JP Morgan there was a sense that you could get a good bonus for being a profitable, law-abiding, trader/salesman/analyst, but you would never get promoted if your ethics were blemished. I am not sure this is an ideal, but it is not a bad place to start in trying to encourage and promote individual ethical responsibility in a commercial environment.

There seems to be an increasing number of scandals and they appear to be getting bigger. A big and still largely unrecognised one is boardroom remuneration. Is abuse of ethical and legal standards getting worse? If so how can the situation be brought under reasonable control?
Dr B. Singh, London, UK

John Plender: Part of the thesis of our book is that the growth of equity-type incentives in the English-speaking countries has greatly increased the temptation for executives to cook the books in order to bump up bonuses and other incentive rewards. We also cite some very eminent business leaders and observers on both sides of the Atlantic who feel that there has been a real decline in ethical standards. The trouble is that legislative efforts to stop the decline, together with more detailed governance codes, can be counterproductive. The risk is that they transform a personal integrity culture into a compliance culture.

What is clear is that ethical standards will remain under exceptionally high pressure as long as incentive structures are at odds with sound values. In our book we argue that it is essential to shift the focus of boards, fund managers, pension fund trustees and analysts away from a narrowly financial, short-term interpretation of corporate performance to a longer term view that takes into account the intangible factors - including an ethical culture - that contribute to a firm’s competitive edge and performance.

Avinash Persaud: I am not sure it is getting worse. I am sure that it is not getting better. There is a role for codes and controls but we emphasise in this book individual responsibility. At the end of the day, behind the corporate abuses are individuals making decisions that, perhaps on greater reflection in the cold light of day, they would not have made. Our book is about trying to help them make the right decision first, rather than regret that they did not do so later.

Modern business appears to face not only explicit ethics related pressure, but also implicit ones. For example multinational’s operating in countries with poor government, bad infrastructure, poor labour standards are held to account by society for ‘not doing something’. The ‘something’ is tantalisingly vague but it is seized upon as evidence that an organisation is ‘failing its responsibility’. Your views on this trend?
Dave Deepak, London, UK

Avinash Persaud: An insightful comment. We try to address this in our chapter on Ethics and Investors, looking at the case study of Talisman’s investment in the Sudan. (Talisman is a Canadian energy company.) I think this is one of the many areas where we do not and cannot have a single answer but rely upon individuals close to the situation to make sure they are asking themselves the right questions. The key question here in my mind is whether the company’s actions are causing any direct or indirect harm that they cannot mitigate. Companies can mitigate their actions as the Equator Principles try to set out. Investing in local training and education is the simplest first step that companies can make when operating in deprived communities.

But of course there are times when a company’s presence or actions in a difficult environment is not an agent for positive change but an obstacle. None of these assessments are easy. Michael Warner of the ODI in London has developed some interesting training on dealing with these sensitive issues.

Your argument has parallels in UK public service, where the post-Nolan ethics revolution has gradually introduced an extensive regime of formal ethics-compliance routines in local government, legislatures, public administration and public agencies. Short-term incentive structures in public-service delivery may also work in the way you suggest they work in commercial life.

But, at least in the public service, I think there’s still a big behavioural question mark: does a formal compliance regime actually put a traditional personal-integrity culture at risk because it outsources and marginalises individual responsibility, or does it rather, when integrated properly into leadership and top-down value-systems of the sort you advocate in business life, reinforce the latter with largely - even if not exclusively - benevolent consequences?

I think it’s an open question. At least in public service, we need more solid behavioural evidence to show a link between formalism and outsourcing in ethics management, and a change in behaviour. Has any hard research on the business world actually shown that link?
David Hine, Oxford, UK

John Plender: There are indeed parallels with the post-Nolan ethics revolution in the UK public service. And I share your view about the big behavioural question mark. The danger that a formal compliance regime puts a personal integrity culture at risk is real in both business and the public sector. But I am afraid I know of no hard research on the business world that would answer your question.

Avinash Persaud: Very interesting. This is not an area conducive to empirical research but we can make some casual observations that while the promulgation of ethics codes has been exponential in recent years there is no tangible sign of a reduction in unethical behaviour. Many of the case studies we look at in our book, for example the recent backdating and spring-loading stock options, are based on abuses after the dotcom bezzles were revealed and ethics became centre stage of new consultancies. I know this is not a satisfactory empirical answer, but it isn’t our main point.

We are not saying that codes and formality on one side and individual responsibility on the other are mutually exclusive, but that first and foremost the former cannot replace the latter and secondly, that having formal codes can lead individuals to pay less attention to their responsibilities.

Many innovative companies depend on high performance of a key team. What is the optimal organisational design to balance corporate economic and social goals with the self-interest of the high performers?
Roy Wares, Vancouver, Canada

Avinash Persaud: Excellent point. We are not against shareownership, we are against “devices” that can be artificially manipulated by those awarded the devices, especially when those doing the awarding are influenced by those being awarded. See our chapter on independent Boards.

I have often worked in ventures where the key teams are given large success-only pay outs or equity, and where this focuses the key players on getting the job done, rather than creating artificial contrivances, it has been a good thing. One issue that has sometimes come up is that large pay-outs for achieving a single milestone (an IPO-say) can lead to the key team taking risks with the post-IPO situation in order to get the IPO done. Here again, we would favour restricted stock to re-align incentives correctly.

John Plender: A hugely difficult question. It is easier to balance corporate economic and social goals with the self interest of high performers in unquoted companies and partnerships than in quoted companies. For example, at McKinsey, the consultants, which is the subject of a case study in our book, there is no eat what you kill award policy for individual partners and firm members, just a single profit and loss account, a commitment to put the client first and an assessment system that reflects the firm’s values.

In quoted companies, we argue in the book that plain equity is a better incentive than stock options. Apart from the problem of motivating people whose options are under water, options can be extremely divisive as between longstanding employees and more recent arrivals if the stock price underperforms. The high tech sector since 2000 provides an obvious case in point. Microsoft has abandoned stock options awards partly for this reason. With plain equity there is a better alignment of interest with outside shareholders and enduring value of some sort unless the company goes bust. Ideally the award should be performance related. But we are still in the dark ages when it comes to methodology - which is one reason why corporate scandals keep happening, people are still cooking the books and boardroom pay often bears no relation to corporate performance.

What one person considers ethical another might not. Of course their are certain issues which are clear cut. Other issues can create varying stances depending on an individuals culture and background. These two elements seem to have significant weight on peoples open on what is ethical or not. As our economies become more and more intertwined, how do you suppose we set ethical values or codes (whether internally or externally) to make sure diversity of cultures within an organisation is represented?
Arash Nazhad, Canada

John Plender: You are absolutely right that establishing ethical values or codes is a big challenge at companies operating in several different parts of the world. We argue in our book that there are nonetheless values to which people in all countries subscribe. For example, people virtually everywhere accept that bribery and corruption is wrong. The problem is one of definition - for example, the difference between a bribe and a gift differs in different cultures. It is for companies to work out what is workable for inclusion in an ethical code. That can only be done effectively through a group-wide process of consultation rather than by dropping tablets of stone from on high. Enforcement is an even bigger challenge than producing a code. In short, no simple solutions and a big learning process.

Avinash Persaud: I agree that ethics are not entirely objective and there are different perspectives. It is one of the reasons why we looked hard for examples of ethical abuses around the world and not just in Houston, Texas. We feel that there are a few objective building blocks however that can form the basis of ethical approach that is not culturally specific - we are particularly focused on conflicts of interest, secret contrivances to put yourself at an advantage and causing unmitigated harm to others.

How does one prevent the managers of a company pursuing policies that favour their own interests rather than shareholders? I am particularly thinking of the modern fashion for share buy-back programmes which enhance earnings per share (eps) when directors/managers often have incentive schemes that are based solely on eps. So by simply using the companies cash in this way, they can obtain bonuses when underlying company performance is pedestrian in the extreme.
Roger Lawson, London

John Plender: This is a central question of corporate governance which boils down to the policing of the principal-agent problem. The answer at a general level and in the specific case you mention is that we have to look to independent non-executive directors to pull their weight on shareholders’ behalf and to shareholders to use their influence and voting power to prevent abuses.

Bonuses and incentive awards should clearly be adjusted to prevent the windfall that otherwise comes from a share buy-back. In the UK, where shareholders have the right to vote on board remuneration policy (unlike the US and many other jurisdictions) the investment institutions are becoming more effective in trying to ensure that boardroom awards bear some relation to corporate performance. But there is still a long way to go.

Avinash Persaud: There is no easy answer. We prefer long-term incentive structures that align managers with the commercial sustainability of the company. (Interestingly in the old days this would be called a defined benefit pension plan!)

You are quite right that the kind of devices you mention create conflicts between the short-term objective of the manager and the long-run objectives of owners.

There are a handful of new initiatives led by fund managers such as the Enhanced Analytics Initiative or the Farsight Award organised by Professor Maineli at Gresham College that promote detailed research into these questions. Check out their websites for some interesting ideas.

In your latest article, you say that with more and more corporate employees acquiring a stake in their companies’ stocks, they find themselves pushing for a short-termist outlook of business to serve their own immediate financial interests. Others would argue that giving employees a stake in the company helps them think in terms of the long-term sustainability of the organisation and consequently, their stake in it. Which do you think is the stronger of the arguments, and hence should businesses be encouraged to make employees shareholders in the company?
Poulomi, Mumbai

John Plender: A good question. Giving employees an equity interest in the company must be beneficial for the reasons you state, though straight equity is preferable to options, which can demoralise a workforce if they remain under water for protracted periods. But the fact that employees owning stock may then be more inclined to go along with efforts to cook the books does not mean that we have to consider a crude trade off between ethics and employee stock ownership.

The solution to the problem is to encourage employee ownership but also to address the “hitting the numbers culture” more directly. That means persuading investment institutions and analysts to focus more on the long term, less on a narrowly financial interpretation of corporate performance.

Avinash Persaud: Shareholdings can align interests between employees and owners, however they are good and bad ways of doing this. Restricted stock may be a good way and we point that out in the book. Stock options, especially where employees influence strike dates and prices has proven to be a way that has many adverse consequences.

It is the ability to manipulate the target, whatever it is, in some artificial way which is the problem - stock option arrangements are more susceptible to this than restricted stock. I remember being overcome with a quaint and unblemished sense of corporatism when I was given my first set of stock options at JP Morgan, but then there was no way in my position then as an analyst that I could manipulate the value of those options.

Do you not agree that the debate needs to move on from whether building and maintaining an ethical corporate culture is a good thing - it absolutely is - to how company managers can use that culture to positive ends? Establishing a unified corporate culture is increasingly important in a global economy where M&A activity is frequent and often crosses borders. Without this culture, staff motivation and retention, and therefore productivity decrease and the risk of an ethics or compliance failure greatly increases.
Paul Basson, President, Integrity Interactive Europe, Monaco

John Plender: Agreed that the debate needs to move on. But the fact is that many executives still do not regard creating an ethical culture as a high priority, or understand why an ethical culture matters. That is part of the reason why so much business ethics has degenerated into a compliance exercise. You are absolutely right in arguing that a unified corporate culture is vital in a world of increasing M&A activity and about the risks posed to ethical values by M&A. It is vital that business leaders send clear signals on a takeover as to the values of the enlarged organisation. A failure to do so leads to confusion and uncertainty, which is often followed by ethical failure, as you say.

On your point about regulation, there is an unanswerable case for improved and more transparent investor governance. It is not acceptable, as the chairman of the CBI recently argued, for institutional investors to be held to a lower level of accountability than the companies in which they invest and increasingly seek to influence. It is worth noting that the International Corporate Governance Network, which represent leading institutional investors around the world, has taken this point and is working on a code for its members.

The use of the Citigroup trade to illustrate unethical business practice relies on the fact that the trade contravened a set of broad principles adopted by the company. No one should be surprised by Citigroup’s failure to dismiss the individuals responsible. After all they were exploiting a market inefficiency. If all such activities were worthy of disciplinary action trading itself would become a questionable activity. However those standing to benefit from Citigroup type behaviour are too often referred to as part of a homogenous group called investors.

Regulation aimed at formally separating investment institutions from divisions which engage in sharp practices would at least help to make clear in whose interests such action is being taken. This identification process should start with the plumbing. Margin accounts and omnibus accounts produce an environment in which accountability is obfuscated. Listed companies bear the cost of compliance despite the lack of legal penalties ( eg the Combined Code). Is it time for an Investor Governance Code?
Paul Marsland, PIRC Ltd

Avinash Persaud: As we discuss in our chapter on investors and ethics, many traders would consider the Citigroup bond trade as clever rather than bad, but in my mind they are wrong.

The Citigroup trade was unethical because it was a secret contrivance designed to give themselves an advantage over their counter parties, that caused, and was designed to cause, unmitigated harm to the market place.

One objective test, and by no means the only or best test is to imagine that Citigroup were to announce at the beginning of the year that one day in 2005 they would do such a trade. Market conditions - liquidity, spread, inclusiveness etc, would deteriorate instantly. “Normal” investor behaviour, pre-announced at the beginning of the year would not have the same impact.

John Plender: We do not share your implied view that exploiting market inefficiency is always right in all circumstances. There are usually other ways of improving market inefficiency than by damaging the market itself, which is what happened to the MTS trading platform after the notorious Citigroup trade.

We continue to find it surprising that Citigroup did not respond swiftly by firing people given that those involved had damaged important clients of Citigroup, broken the rules of the MTS market place, incurred the wrath of the Financial Services Authority and inflicted reputational damage on the group. If this is not sufficient reason to fire someone, one wonders what is.

It is worth reiterating that any executive, employee or trader ought, in the course of their business, to ask whether their actions will damage stakeholders such as customers or clients of the business. If the answer is yes, they should then ask whether it is right to go ahead with the action, or to seek to mitigate its damaging effects. Under pressure, which is how most of us work, this is not easy. But it is what we should aspire to. I should add that in writing our book on ethics and finance we do not claim any moral authority. We just believe that economies, markets and companies work better if people subscribe to ethical values and that it is worth discussing how to achieve an ethical culture.

Can ethics or ethical values be taught? Or in other words, can an individual learn ethical behaviour and, if so, how can this be achieved?
Jasper Platz, Charleston, S. C.

Avinash Persaud: I believe a sense of right and wrong is learned, or largely so. However, our book’s main premise is that most individuals and, believe it or not, finance professionals, have a sense of right and wrong. It’s just that they consider it right to hang it up outside the door with their coats when they come in to the office every day. They need to take their own ethic and responsibility inside. And to help them we suggest some questions they can ask themselves on a regular basis when confronted with “uneasy” situations.

Is it necessary for a company to take socio-political responsibility into account when selecting business partners? For example, should a western company conduct business with, say, an Iranian company or the Iranian government whilst Iran is guilty of holocaust denial, threatening a UN member state (Israel) or flouting respect for UN sovereignty regarding nuclear proliferation?
Joel Wolpert, South Africa

John Plender: I would argue that a company should be responsible in selecting business partners, but that you have to consider the interests of other stakeholders in the equation including the people of the country concerned and the needs of your customers. There is also a screening versus engagement argument. In some cases engaging with a failed or malign state may do something for the living standards of desperately poor people. In other cases not.

In the book we point out that in South Africa under the apartheid regime General Motors tried first to engage, by insisting on standards in its plants that flouted the apartheid laws. Then when it recognised that its efforts were not having any impact on the government’s policies, it pulled out. So no simple answers - as so often with business ethics, which is why the subject is interesting - and in the case of Iran it would depend on the wider ethical cost-benefit analysis, taking into account the relevant stakeholders, in the individual circumstances.

Avinash Persaud: I think a company should pick partners that the owners and employees are comfortable working with on the basis of transparent and fair concerns. You may not feel comfortable working with an Iranian company for a set of reasons and should spell that out to your managers and employees. If you decide not to work with them, it would then be ethical for you to apply the same tests to your partnerships in other countries and to be objective about the application of this test.

You may instead decide to make a distinction between the State and the company and individuals. I feel deeply uncomfortable about Israel’s recent actions in the Lebanon and its countless transgressions of international law. However, this would not automatically stop me working with an Israeli business partner and I don’t hold every Israeli responsible for the actions of its government.

Has economics yet got an answer for pricing in ethics into financial models?
Katharine Morton, Cambridge, UK

Avinash Persaud: You can write a model for anything if you put your mind to it. Seriously though, there is a growing literature on the economic value of trust that comes from behaviour driven by ethical norms. I recall an interesting conversation with Dr Stephen Spratt of the New Economics Foundation on this literature. Put simply, markets would collapse if there were no basic ethical norms and you couldn’t trust buyers/sellers/quality/rights . . . ever tried to buy a house lately?

Devotees of Adam Smith, sometimes need to re-read the master’s treatise on “Moral Sentiments” to see the importance he attached to issues of ethics and morals. The absence of trust in economic relations can be a major obstacle in many developing countries.


The new millennium has been marked by a succession of corporate scandals caused by astonishing ethical lapses. What started with Enron has turned out to be a global phenomenon with enormous repercussions.

In response many companies have expanded their governance codes and compliance functions which has exacerbated the problem by encouraging a risk management culture rather than an ethics culture. Too many boards have delegated the task of ethics to ethics officers, who in turn have relied on consultants to define the company¹s values. Ethics has become something that “other people” do in the company.

Mr Plender says: “A mentality sets in whereby ticking the box is regarded as satisfying all ethical as well as regulatory requirements. Our aim is to encourage people to think and question in order to come to their own conclusions as to what doing the right thing means when faced with the extraordinary variety of ethical dilemmas thrown up by modern business.”

When compliance is not enough

The day Dr Evil wounded a financial giant

The market discipline that is not so tight

All you need to Know about Ethics and Finance (£19.95) will be published in September 2006 by Longtail Publishing Limited. It is available for pre-ordering on 020-7938 1975 or at www.allyouneedtoknowguides.com ISBN 0-9552186-2-4

Copyright The Financial Times Limited 2018. All rights reserved.

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