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Ethics: Don’t Leave Home Without Them

January / February 2003 Edition of the Corporate Board Member.

By Rob Norton

American Express veteran James A. Mitchell says ethics translate to better performance—but maybe only over the long term. If Wall Street can’t wait, tell it to invest somewhere else.

The crisis of confidence that has engulfed corporate America results from years of neglect of ethical considerations by senior managers, according to James A. Mitchell. In 1999 Mitchell retired as executive vice president of marketing and products at American Express Co. Before that he’d served as chairman and CEO of IDS Life, the nation’s 14th-largest life insurance company and an American Express subsidiary.

Mitchell is now Executive Business Fellow for Leadership at the Center for Ethical Business Cultures in Minneapolis, which works with the University of Minnesota’s Carlson School of Management and the University of St. Thomas College of Business to help executives develop ethical and profitable cultures. He believes the two qualities are far from mutually exclusive. Mitchell tells the business leaders and directors who attend the center’s seminars and conferences that they can not only win back the confidence of the public by improving their companies’ ethical cultures but also add economic value as they do so. He spoke recently with Corporate Board Member’s Rob Norton.

How badly do you think the ethical reputation of American corporations has been damaged by the recent scandals?

It’s pretty bad. A lot of people didn’t trust corporations to begin with, and lately they’ve had plenty of evidence that they were right. A recent Wall Street Journal/NBC News poll shows that one-third of Americans have “hardly any confidence” in big-company executives—the highest proportion to think that way in more than 30 years. The same kind of disaffection has taken root within the corporation. A survey conducted last year by Marcus Buckingham, who’s a senior consultant for the Gallup Organization, found that only 26% of American employees consider themselves engaged—loyal and productive—while 19% consider themselves actively discouraged—unhappy and spreading their discontent. Even before Enron, WorldCom, and the other corporate scandals, the emphasis for the past decade was on short-term profitability, with few people in business concentrating on the long term or claiming that ethical considerations occupied a high priority in business decision-making.

Yet you see this as an opportunity?

This crisis is a tremendous opportunity for those corporations that work hard on strengthening their ethics and building trust. Suppose you had 80% of your employees engaged. You would be more than twice as productive, because your company would be the kind of place where people felt they could show up for work without feeling bad about what they did. The company that genuinely takes ethics seriously—that says it and means it—has a huge advantage in attracting ethical and highly motivated employees, and it feeds on itself. If enough companies took this seriously, over time the public perception of corporations in general would improve markedly.

Are there any data showing that ethics pay?

One of the problems is that there are not all that many numbers and studies. There are a lot of variables, and it’s hard to get them to sit still over time. The people who’ve actually thought about this are in academia, and tend to be philosophers. Some have taken the position that you shouldn’t even have this conversation, that any attempt to justify ethical behavior on economic terms undermines the arguments. The ones who’ve tried to put numbers on it have tended to look at it from the point of view of compliance—that if you don’t do the right things, you’ll get fined and sued.

But the research that does exist is compelling. In Corporate Culture and Performance, for instance, John Kotter and James Heskett of the Harvard Business School found that over an 11-year period, companies that care deeply about their customers, shareholders, and employees—all ways to measure ethics, in my opinion—increased revenues by an average 682%, compared with 166% for the others.

What were some of these ethical companies, and how did they do compared with competitors?

They included firms such as Target [then Dayton Hudson]. Target scored 6 on a 7-point scale measuring the extent to which a company shows excellent ethical leadership, compared with a 4.2 score for its competitor J.C. Penney, which the authors felt didn’t care as deeply about those three groups. Over the same period, Target’s annual income grew twice as fast, return on invested capital was almost 15% better, and the stock price grew 63% faster.

My own experience at American Express convinced me that ethical behavior does pay. We tried very hard to run the whole company ethically. During the nine years that I led IDS Life, it became the fastest-growing and most profitable large life insurance company in the United States, with a nine-year compound growth rate of 23% in net income and after-tax return on equity of 21%.

What do companies need to do to behave better ethically?

First they need to get away from the short-term way of thinking that’s dominated business leadership in the past 10 years, and which produced the casino mentality that’s caused the current crisis. You’ve got to stop concentrating on next quarter’s stock price and balance the longer-term interests of all the stakeholders. Not just those of the stockholders, and not even just those of customers and employees, but also suppliers, competitors, and the community. You can always rationalize things for the short term, but if you think about things over time, caring about all the stakeholders will create value for everyone. Of course, none of this is intended to devalue the importance of basic notions like corporate strategy and competency. If you don’t have those things, you’ll fail at whatever you do.

Leadership effectiveness is the next thing companies have to focus on. Leaders need to articulate the mission and values of the firm, and do so in a compelling way. Most CEOs are incredibly busy, but they need to spend time on this. It’s a huge problem in business today that people don’t see CEOs are caring about the customer and the community. Leaders must embody the values they espouse—they’ve got to walk the talk.

Finally, process integrity is important. The ethical culture must be ingrained in a company’s core processes. The recognition and reward system must be aligned with the firm’s stated mission and values.

Focusing on quarterly earnings reflects anxiety over what Wall Street thinks of you. How do you change that attitude? Can a company afford to ignore Wall Street?

You can’t ignore Wall Street, but you need to put it in its proper perspective. Owners—and Wall Street is a decent proxy for them—are one of the stakeholders you need to pay attention to, but not the only one. You need to say, “I will deliver not just good value to you, but superior value over time. But you have to be willing to look beyond the next quarter. If you’re not prepared to invest in my company over a three- to five-year time horizon, then you ought to buy somebody else’s stock.”

What’s the role of the board of directors?

The directors are key. I believe that ethics can and should be on the agenda right at the top of the organization. Sure, the CEO is responsible for recommending things like the mission and values statements to the board. But it is the board’s responsibility to see that those aren’t just nice words on coffee cups. The board needs to hold management responsible not just for the financial results—it needs to be looking at such things as employee satisfaction, customer satisfaction, and market-share growth, which in turn are driven by employees who are highly motivated.

What specific steps should directors insist that management take?

There are four things the board needs to do. First is to make sure the corporation’s mission and values reflect the idea of balancing the interests of the key stakeholders—customers, employees, and community, as well as owners.

Second is to insist on the right metrics—to measure and hold management accountable for how the company is doing with respect to each of its stakeholders. Management should conduct an anonymous values survey of all employees annually and report the results to the board. Employees are the ones who create the economic value, and they’re also the first ones to know if the company is not walking its talk. You should have write-in lines for people to describe behavior they think may be inconsistent with corporate values and ethics. If you ask them sincerely, they will tell you.

At American Express, we asked the same 70 questions about corporate values every year in an anonymous survey. By and large, the results we got came because people saw us living those values and taking them seriously. We got anonymous write-ins questioning things employees thought weren’t consistent with what we said we were about. Usually it was a case where they thought we weren’t treating customers consistently with our values. About 80% of the time you’d look at those notes and say, “My God, could we really be doing that?” Then you could go and fix it, and tell the employees, “We don’t know who told us this, but thanks for the feedback, and here’s how we fixed the problem.” A system like that reinforces itself if you’re serious about it, because people see the results. If you’re not serious, people will realize it and rightly think you’re hypocrites.

One question you have to ask is why you don’t see more CEOs and directors speaking up and condemning the kind of conduct that’s been in the newspapers this year. I think it’s because they aren’t so darn assured that their own skirts are clean. Even if the company is acting ethically, maybe some division isn’t, or maybe some individual off somewhere is cooking the books. They just don’t know. That’s why these employee surveys are essential. Combined with customer-satisfaction surveys and surveys about the company’s community, social, and environmental performance, they can give management, and the board, the information it needs to ensure that the company is behaving ethically.

The third thing directors need to do is to reflect the results of these measures of employee, customer, and community attitudes in the compensation of the senior executives. You can’t say this is important and then say, “It’s 2% of your compensation.” This is the real leverage point. Employee and customer survey scores need to be big pieces—25% each, for instance.

Executive compensation in general needs to reflect an appropriate balance between the long term and short term. During the ’90s the emphasis shifted almost entirely to a short-term mentality, with executives feeling they were being forced by investors to concentrate on next quarter’s earnings. You need to get back to a proper balance of investing for the next three to five years. Stock options are appropriate as part of compensation, so long as they are not excessive and reflect true economic value creation over time. They should only vest after five to 10 years, say. When a CEO walks away from a troubled corporation with hundreds of millions from stock options after a few years, that’s outrageous.

If executives are only interested in short-term compensation, they probably aren’t going to strike the right balance between customers, employees, and owners anyway. You want people who are competent and are great leaders, but you want people who get it. The leaders you’re looking for are executives who want to build a great company, and who are willing to stay put and get a meaningful part of the value over time.

The fourth and final thing directors must do is to be prepared to replace the CEO if overall results are unsatisfactory. If you’re serious about this stuff, you can’t just say it didn’t matter. You must be prepared to act.

Does anything else need to be done to restore the public trust?

The legislation that Congress has enacted—the Sarbanes-Oxley Act—and the new rules adopted by the New York Stock Exchange and the Nasdaq are a good start. I think they have that about right, an appropriate balance. The public is going to demand that some senior executives go to jail, and I hope some do. It will help. But it’s important to get beyond the compliance mentality—“Let’s not screw up”—and move on to more proactive behavior.

How long will it take for business’s reputation to recover?

Obviously, for some companies the answer is “Never.” But for the American corporation in general, it’s a five- to 10-year deal, assuming we start now. If companies take the kinds of steps I’ve outlined, and work hard at it, they will start to see results in three years and they’ll really see them in five. They will become the employers of choice in their industries a lot sooner than that, and as they attract able, highly motivated, highly ethical people, the business and financial results will follow.

Once that begins to happen, executives won’t have to trumpet the results. They will speak for themselves. People will notice you’re different and ask why you’re doing so well.

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