Best of 2011: Ethical Storm Brewing
There is a fundamental difference between the Enron-Satyam type of corporate scandals and the recent ones
Publicly held firms in countries perceived as less corrupt are valued at bigger market premiums than those in places considered more corrupt
People Matters in its Jan-Feb 2011 cover story ‘Ethical Storm Brewing’ delved into the unholy nexus between politicians, promoters, media, and shareholders which aptly reflected the darker side of India’s growth story and suggested measures which could possibly bring back much needed confidence. Since then, developments on the anti-graft arena have been in a way historical. Dumped by successive governments in the last four decades, a strong Ombudsman is set to see the light of the day, thanks to the mass movement and efforts of the civil society.
But herein lies the twist, India Inc. which so far has been vehement on its attack for lack of governance and transparency in the executive and legislative, itself does not want to be under the ambit of the anti-corruption watchdog. A section of it supports measures to legalize one form of corruption and wants the law to be amended accordingly. As far as India Inc. is concerned, in order to have a greater degree of transparency in its transaction, the role of company's board as a strategic advisor and conscience keeper needs to be sufficiently explored. In essence, this story made a strong case for maintaining ethical behavior to ensure long-term economic growth and for managers to be caretakers of such behavior.
Ethics and governance are downright boring topics. While we are all interested in the vicarious details of scam – how much money did so and so make, who was the go between, how was the physical cash handled, how pathetic that no one has been booked – few look into the origins of such behavior and the possible mechanisms that could deter actions of the kind that have been exposed recently.
This story attempts to create a case for a new kind of corporate governance – one where the overriding principle of protecting the minority shareholder is replaced by a larger emphasis on behavior within ethical boundaries. As compelling as it is to advocate ‘ethics for ethics sake’, the story tries to create a case for maintaining ethical behavior to ensure long term economic growth and for managers to be the caretakers of such behavior.
Protecting the small guy: From Enron to Satyam
The Enron scandal of 2001 created a new awareness in the failure of corporate governance involving the culpability and collusion of the company’s management, board, auditors and stock market analysts. The situation led to a widespread debate and discussion on the control and strategic responsibilities of the board, on alignment of management compensation with long-term company objectives and on the flow of information from within the company to its shareholders – all with the aim to protect shareholder interests.
India had its share of corporate scandal with the Satyam saga, wherein the control failure of the board working closely with the company’s unscrupulous promoter-management led to a destruction of wealth for minority shareholders. The central theme in the post-debacle analysis was a re-examination of roles of the board, the management, the promoters, the auditors and market analysts – again with the purpose of protecting the interests of minority shareholders, a diffused entity with the least representation and with minimal access to information.
A new ethical dilemma
The last couple of years in India have demonstrated a different type of corporate scandal in sectors like telecom and mining – one where collusion between politicians, officials, media and promoters (with the aid of managers and the subtle nod of shareholders) has led to the siphoning of national resources on a scale hitherto unimagined. The gory economics of the telecom scam were made public by a CAG report and a subsequent media jamboree – including details like loss to exchequer, personalities/business houses involved and the nature of transactions publicized to an awestruck audience in the form of tapes.
There is a fundamental difference between the Enron-Satyam type of corporate scandals and the recent ones. The post-mortem of these recent scams is not centered around protecting the shareholder, not even the minority shareholder. Ironically, this analysis is centered around how to deal with shareholder greed that ends up in complex collusion – on how to save the system of capitalism from the capitalists.
Does bad ethics make for bad economics?
While most Indians are outraged by the unethical nature of such transactions, there is a common perception that such scams notwithstanding, the larger long term economic interests of the country remains intact – that the India growth story survives in spite of public-private corruption and will not be derailed by any such behavior. What needs careful analysis here is if this belief is substaintiated and if not, how do such instances of collusion and corruption adversely affect long term economic growth. And, how managers should be incentivized to first conduct themselves ethically and then look to maximize shareholder value.
There exists a very strong case for transferring public assets at affordable prices from inefficient government control to private entrprise for the benefit of both consumer and shareholder. Telecom itself is a prime example of how transfer of airwaves at ridiculously low license fees has ultimately benefited the customer and spawned a communication revolution that now touches the poorest and gives access to scalable solutions for information and transaction in an otherwise access-starved economy.
Hence the question: Is corruption, even of epic proportions, a small price to pay for accelerating the process of transfer of assets from lazy-public-sector to efficient-private-sector? Is there a larger economic price to be paid for such unethical practises and hence, can long-term economic interest become the motive for enacting or regulating ethical behavior? Or, are businesses destined to become the ‘new politicians’ – representing a class whose economic interests are rarely affected in spite of their most visible flouting of laws, rules, norms and ethics?
Reputation, hot money & disparity
In spite of what most think, the primary negative effect of corruption is the damage it causes to the India Shining story - in terms of reduced long-term investment and reduced direct investment. The reasoning is simple – unethical behavior will make it difficult for companies to associate with investors, businesses and consumers in countries with strong policies for preventing dishonesty. A recent study by Charles M.C. Lee, an expert on markets and accounting at Stanford’s Graduate School of Business shows that ethical lapses matter in the market value of companies. Over the long run, publicly held firms in countries perceived as less corrupt are valued at bigger market premiums than those in places considered more corrupt, according to Lee. In his research, corruption was defined as the “misuse of public office for private gains”. This could include bribery of public officials, embezzlement of public money, and kickbacks in public procurement. Corruption isn’t just a matter of appearing “unsavoury”, Lee said during a public address. There is evidence, linking corruption to “social and economic ills” such as lower economic growth, less foreign direct investment, higher military spending, and worse healthcare and education, he added.
Another long-term economic repercussion of a corrupt system is that of hot money flows, both inward and outward. A decent portion of proceeds from corruption in India has funded asset booms – like the one in real estate, taking prices and rentals beyond the reach of ordinary citizens. Simultaneously, a large portion of ‘corruption money’ leaves the country to havens abroad and is never deployed in the local economy. Estimates predict that between 2000 and 2008, India had a mindboggling USD 125 billion in cumulative illicit capital flight.
A different kind of hot money that follows corrupt practises in the transfer of state assets to private enterprise is that of short-term focused foreign (and domestic) investment. The expectation and immediate aftermath of companies receiving licenses/rights for a fraction of their ‘real value’ prompts speculative rallies and dramatic pullbacks much before such companies can actually demonstrate operational capability. This could well be one of the main contributors for the tremendous rise in telecom service provider stocks by early 2009 followed by a near 50 percent loss in market value over the period since. In the long run, such hot money flow (and flee) could have devastating effects – something our South East Asian neighbors witnessed a decade ago.
The final long-term impact of corrupt practices is the increased disparity in income and wealth levels between various sections of society. With the kind of collusion seen in the recent telecom scam and in various mining scams, the profiteers include the new ‘masters of the universe’ - politicians, officials, promoters of companies, media persons, senior corporate managers and ultimately, minority shareholders as well. Which leaves out the non-white-collared, non-shareholding class that comprises more than 90 percent of the legitimate populace. While this class does occasionally benefit as consumers, the question of increased wealth disparity between them and the new ‘masters of the universe’ is beyond debate.
The imperative for managers and B-schools
In an age of tremendous pressure for managers to deliver results and of sufficient compensation to justify such pressure, there is little to dissuade managers from indulging in unethical behavior to deliver better results – except for ethical motivation from within and for peer pressure. And this is where HR and senior managers can make a difference by recruiting for the right ethical attitude. Author and management guru Gurcharan Das has a strong view on this, “Hiring the right people is extremely important - recruiting people with character; what the person knows or his intellect is not as relevant. Hiring people is one of the most important decisions for the organization; people you bring inside the organization will collectively determine the character of the organization. The time when people join the organization is the time when companies need to tell them what is right and what is not right and create the right habit. Of course, the management should behave as they say and may need to protect their employees for any business misjudgement but never for ethical lapses.”
There is a larger role for education, especially business education, in reinforcing ethics that is vital for business sustainability and for economic stability at large. Prof. M.J. Xavier, Director of IIM Ranchi is a firm believer in the role of holistic development of an individual as a part of business education. “Business education should be reformulated with the triple bottom-line approach - Profit, People and Planet. Currently, management education is entirely focussed on the first P - profit. When it comes to people, business should be relevant to the society in which it operates. Inclusive growth, ethical behavior and regional development must form a key component of business education. The last P is becoming important as we are destroying mother earth very rapidly. Sustainability and green initiatives should also form a major part of business education,” he says.
In the face of a large-scale collapse of ethics, most solutions seem either thin or impractical. Yet, ironically, there is widespread dismay at the current state of governance from people across professions and the call for systemic reform is uniform. Most of the experts polled point to systemic reforms in the reduction of discretionary powers with ministers that have increased with economic growth and with larger access to resources. Another pointer for systemic change is to increase the autonomy of investigating agencies and to fast track the judicial process that handles financial crimes, bolstered by laws that fine corporate entities breaking laws and make it difficult for companies to deflect blame on independently acting employees in the event of bribery. However, any such change would require political will and corresponding legislation – something that is completely missing and worse, is the biggest obstacle in the path of reform towards ethical behavior.
At a corporate level, the role of a company’s board requires greater attention. While its role as shareholders’ representative has been scrutinized over the last decade, the board’s role as a company’s conscience keeper and strategic advisor has not been explored sufficiently. Also, an expansion of the Whistleblower Bill to include corporate whistleblowers (which the bill surprisingly omitted) could create a way for protecting employees willing to provide information on corrupt practises within the company.
The consumer and the employee can also make a significant impact in forcing companies to behave ethically. When consumers and employees consciously begin to discriminate between brands from ethical and ‘unethical’ companies, companies will be forced to re-think their corporate decisions.
Ethics in politics, anybody?
At the end of the day, however, none of these solutions would work without a general ethical awakening among the masses – a task for religious bodies, schools, media, NGOs and individuals alike. After all, the rot visible today should be a fair reflection of the drop in individual and community values. Finally, there is one critical issue on which few people have a favourable view – one of ethical behavior among people occupying positions of power. At a time when ministers are appointed to ‘protect’ friendly business interests, when corruption in public office is an expected norm and when personal conflicts of interest in public office are no longer a hindrance to operate, faith in public officials and politicians is at an all-time low.
While the media and corporate India are going through a period of intense reflection and soul-searching, the measures taken by government to curb such behavior are cosmetic at best and largely non-existent. The need of the hour to solve this collective problem of “global warmingesque proportions” is one of serious structural reform and a visible return of propriety and ethics in public life. While that may sound logical and may be the only way ahead for governments, experience suggests that it might be too much to ask of our leaders.
Is legalizing corruption worth it?
In a year rocked by anti-graft campaign, there seems to be a diffused focus on whether or not the same should be meted out to the corporates. While the basic tenants of the proposed (Jan) Lokpal Bill is to weed out corruption from the echelons of bureaucracy and political executives, it has somehow remained silent on weeding out the menaces of corruption that are prevalent in business world. In fact, there are no provisions for the Lokpal to act against corporates and business enterprises that indulge in corrupt practices in consonance with the executive and legislative class.
The proposed Ombudsman does not offer much in terms of what should be done to take care of the supply side of corruption. The Central Vigilance Commissioner, Pradip Kumar, brought to light this issue when he reopened the debate on the mandate of the proposed (Jan) Lokpal by suggesting that corporate and NGOs should be brought under the purview of the anti-corruption bill to check graft effectively. The memories of 2G scam brings forth the point that corporates too have played crucial role in abetting corruption and hence it makes sense to bring them under the jurisdiction of the proposed ombudsman. A few political heavyweights made a strong pitch for the same in the parliament, perhaps in their bid to buy time or else to divert the larger agenda-whichever may have been the case. The only rationale of not including it in the present text of the Ombudsman perhaps may be to deal with these in a later stage.
The industry and India Inc. too stand divided in their response to this new debate. Representatives of industry lobbying groups (CII, FICCI and ASSOCHAM) in their separate representations before the Parliamentary Standing Committee on Law and Justice and Personnel have expressed their reservations over inclusion of corporate sector under the ambit of the anti-corruption watchdog. While India Inc. stalwart Narayan Murthy agreed that no corporate leader should escape the extreme level of scrutiny that they expect the bureaucrats and politicians to come under, there are industry veterans who feel that businesses should be allowed to function in a liberated environment as too much of policing will kill entrepreneurship. A section of India Inc. feel that corporate-centric Lokpal is counter-intuitive; multiple watchdog will create confusion and restrict autonomy and independent decision making. While concerns expressed seem superficially justified, the contrarian view points towards business ethics and more importantly on the tenacity of moral grounds that India Inc have in the past used to question the government on transparency and accountability. A just and fair system would ideally be one where transparency and accountability extends to the corporate too.
Economist, Kaushik Basu – the chief economic advisor to the finance ministry, suggested that legalizing ‘harassment bribes’ could help check the endemic of corruption, which has found support from industry leaders Narayan Murthy and Adi Godrej. His logic is that legalizing paying bribes would help members of the public blow whistle on corrupt officials. But doing so would imply that we as a nation accept that the widespread and deep reach of ‘corruption cancer’ is impossible to tame. Their case for bringing in changes to the present law which treats bribe givers and takers as equal offenders will break the social fabric of justice. Further Godrej suggests that “small payment” of speed money by industry could be legitimized for a “short period of time”. Legalizing small amount of speed money could bring about a greater degree of efficiency in business transactions wherein the government. This could help minimize the overall overhead cost of the business in the long run. The question, which one will faced with if such opinions are given a legal shape will be on the relative terms ‘small’ and ‘short period’. Further legalizing corruption, however small that might be, is devoid of merit as it jeopardizes the very essence of the fight to weed out corruption.
On one hand, India Inc. wants a business environment that is devoid of corruption and is transparent; on the other hand it does not want to be under the purview of the Ombudsman. At the same time it also supports that one form of corruption should be legalized. They have their reasons and rightly so; but with these inherent dichotomy, the question remains as to how rewarding will the journey to create a corruption free nation be?