Ethics Programs: Ethics Pays in So Many Ways

 

Who wants to see the profits of their companies double or triple while building customer, investor, and employee loyalty? Everyone! Yet most companies have no idea that they already have an inexhaustible product that can do all these things. It's easy to manufacture, doesn't pollute, and attracts thousands of customers lined up around the block. 

 

This magic product, ethics, is the most tangible and irreplaceable asset of your company. And we want to help you deter fraud by giving you ways ethics pays that you can share with management. 

 

KEEPING ETHICS SIMPLE 

"A lot of long words missy. We're but humble pirates. What is it you want?" to quote the famous pirate, Captain Barbosa, from the Disney movie, "Pirates of the Caribbean: "The Curse" of the Black Pearl." What is it we want from our employees, our suppliers, and from our corporations? The word, ethics, is derived from the Greek word, ethikos, which means character - the distinctive, noteworthy quality of an individual or organization. 

 

An entity's character is as important to the company as it is to an individual. It can be a company's "good will" or "brand recognition" with the public. It takes years to build up a good reputation and only seconds to lose it. A company's character is its most valuable asset; no amount of production capacity or human capital can replace a good reputation. 

 

Ethics and character. It has a universal appeal, and it inspires and uplifts everyone who witnesses it and everyone who demonstrates it. Ethical behavior is the bedrock of every successful society, individual, company, and organization. The beauty of ethical behavior is that everyone understands it in every culture, and every language regardless of age, race, or income level. 

 

COMMON MYTHS ABOUT ETHICS 

Some might say that's a nice sentiment but not one that pays for itself. Ethics is commonly thought of as a "feel-good" notion that can't hurt, but one that sure doesn't help the bottom line. At best, many companies feel ethics is an intangible idea that needs to be promoted in the stockholders' annual report but nothing on which a financial analyst or CPA can calculate a rate of return. It's not a profit center but a cost center, right? It can't increase sales and attract investors. Customers won't pay more for a product from an ethical company, will they? 

 

New research by The Institute of Business Ethics, leaders in promoting corporate ethical best practices, has shown for the first time that companies with a clear commitment to ethical conduct outperform those that don't. 

 

The research is the most thorough study ever carried out in the UK about the relationship between business ethics and business performance in large companies. Using four indicators of business success - economic value added (EVA), market value added (MVA), price/earnings ratio volatility (P/E ratio), and return on capital employed (ROCE) - it compared two groups of companies: those with a demonstrable commitment to ethical behavior through having a published code of business ethics and those without. Their performances were then analyzed over the five years from 1997 through 2001. On three of the four indicators (EVA, MVA, P/E) the companies with codes were clearly superior, and on ROCE the results were less clear but supported the overall trend. 

• On Economic Value Added, the sample of companies with codes outperformed those without over a four-year period. 
• On Market Value Added, the performance gap was even more marked. 
• On Price/Earning Ratio, the more demonstrable ethical companies showed far less volatility than the remainder. 
• On Return on Capital Employed companies with codes underperformed those without between 1997 and 1999. Between 1999 and 2001, however, the trend was reversed, and ethical companies were clearly superior performers. 

 

The report also suggests that having a code of ethics equates to a higher than average score in Management Today's ranking of Britain's Most Admired Companies and in the SERM (Safety and Environmental Risk Management) Risk Reduction Rating, and is therefore a strong proxy indicator of genuine ethical commitment and a well-managed company.1 

 

ETHICS ARE APPEALING TO CONSUMERS 

The market research organization GfK NOP surveyed 5,000 consumers in the United Kingdom, the United States, France, Spain, and Germany and found that about a third of those polled said they would pay a 5 percent to 10 percent premium for the products and services from an ethical company over its competitors.2 This phenomenon is widespread. Additional studies have shown that consumers will "put their money where their mouths are" to support ethical companies over their less ethical counterparts. According to a 2003 survey, 80 percent of U.S. and European consumers are willing to pay more for goods and services from a company with a well-regarded labor and environmental record.3 

 

Now on the negative side of consumer sentiment - the 2007 Edelman Trust Barometer found that Canadian consumers are growing more likely to boycott and speak negatively about companies that they feel are untrustworthy. According to an annual survey of global opinion leaders (who are defined as college-educated people between the ages of 35 and 64 engaged in media, economic, and policy affairs and have a household income in the top quartile) 86 percent of Canadians polled refused to purchase products or services from brands they didn't trust. The survey also found that 77 percent of Canadian consumers have refused to invest in such companies and 85 percent of the survey's respondents said they have spoken critically of untrustworthy companies to acquaintances.4 

 

Clearly this demographic group is one that no company would ever want to lose as its customers. Yet, most companies' lack of commitment to fostering ethics in its products, placement, and manufacturing suggests either ignorance on this issue or a self-destructive tendency. These studies make it apparent that ethics is an important component of a company's product, pricing, and desirability. And advertisers thought celebrity endorsements alone sold a product! These studies and polls strongly suggest that for this consumer generation, companies should quickly start building ethics appeal into their products if they want to capture the attention and loyalty of their consumers. 

 

ETHICS ARE VALID DIFFERENTIALS TO INVESTORS 

Investors, just like consumers, like ethics in the workplace. A GlobeScan survey (GlobeScan is billed as a global public opinion stakeholder research firm) found that 70 percent of Americans reported that a company's commitment to social issues is important when deciding those stocks or mutual funds in which to invest.5 Investors look for any corporate social responsibility seal of approval (such as Fortune Magazine's annual ranking of "The Most Admired Companies" and the Sierra Club Stock Fund Ranking) and a good corporate ethics track record. 

 

On the other hand, investors also look to unload stocks of unethical companies. Sixty percent of worldwide investors surveyed in a study stated that they would sell shares in a company they believed was behaving in a socially irresponsible way despite high earnings.6 

 

Supporting the results of these two surveys, Spuma M. Rao, Ph.D., and J. Brooke Hamilton, Ph.D., found in their research of stock prices that there's a statistically significant connection between ethics and profitability. The researchers selected 57 large and well-known public companies in a five-year period that were involved in scandals reported by the Wall Street Journal. The researchers divided the reported unethical conduct "events" into five categories including bribery, employee discrimination, environmental pollution, insider stock trading, and violations of laws and regulations. 

 

When examining the statistical data, Rao and Hamilton found that actual stock performance for each company involved in unethical conduct was significantly lower than the expected stock value based upon its financial performance. To determine the true impact of reported unethical conduct on stock prices, the researchers statistically factored out numerous extraneous influences from their calculations to isolate the influence of the misconduct. These findings clearly indicate that a firm's discovered and publicized unethical conduct has a measurable negative impact on its shareholders: stock value depreciation for a significant period. 

 

CEOs be advised; ethical lapses that depress stock prices can offset or diminish years of corporate successes in sales, profitability, and product enhancements.7 

 

In laymans' language, investors will dump stock or avoid it when they read about companies' foul play, corporate shenanigans, and environmental and safety lapses. Investors don't completely forgive or forget a firm's unethical conduct, so its stock price could be deflated for some time. 

 

So are ethics bottom-line worthy? Should CEOs and boards of directors view ethics as critical components of their products? Is it enough to just build quality into a product but still be seen as socially irresponsible or unethical? 

 

Research overwhelmingly indicates that the answer to these questions is no. Consumers do care if a company and even its vendors behave in socially irresponsible ways. When major media outlets reported in 1997 that some of Nike's shoes' and clothing vendors ran their factories like sweatshops, the outraged public threatened a product boycott. Nike, the most popular brand in the market, said it was unaware of these problems. 

 

Nike regained the public's trust by denouncing such practices, firing offending vendors, and establishing a world-leading inspection and audit program for its overseas' vendors to ensure they behaved in a socially responsible way.8 

 

RECRUITMENT ADVANTAGE OF ETHICS 

Excellent ethics, obviously, will attract excellent employees. The 2004 Survey on CSR Reputation Effects and MBA Job Choice, conducted by the Stanford Graduate School of Business, revealed that 94 percent of MBA students surveyed would choose to work for a company with a better corporate social responsibility rating than a competitor even if it meant less pay or benefits.9 Quality job applicants will see ethics as an indispensable and invaluable asset of any company's balance sheet. 

 

GOOD MORALS ARE GOOD FOR THE COMPANY 

"It did not matter what policies and procedures a corporation espoused or put in its handbook. Workers react to how they are treated," says author Millie Kresevich, the regional loss prevention development manager for Luxottica Retail in Cleveland, Ohio.10 Kresevich notes that it shouldn't come as a surprise to anyone that "companies that don't treat their employees well or fail to establish a culture of high ethical and moral standards for everyone - executive and staff - produce disgruntled employees with low morale and morals who are more likely to steal than happy employees." 

 

So some employees steal a few pencils - big deal. Well, it so happens that theft by employees is a big deal; every CEO should care about it because of its impact to the bottom line. As we know, the ACFE's Report to the Nation estimates that U.S. organizations lose an estimated 7 percent of annual revenues to all fraud. Fraud is a big deal because an additional 7 percent of revenues a year would more than double the bottom line for many companies. 

 

The 2007 listing of the largest 25 Fortune 1000 companies shows that they have an average profitability of 7.88 percent and these companies are among the most successful ones in the world.11 Think of what the income booster of even a couple of those 5 percentage points would do to the stock price and how it would enable your company to more competitively issue stock to fund expansions and acquisitions. And consider how this amount of money could enhance your company's product research and development efforts and the competitive advantage you would enjoy through such expenditures. 

 

ETHICS ARE A PRODUCTIVITY ENHANCER 

Low morale and morals cost an organization's productivity. The Gallup News Service's Annual Work and Education poll found that surveyed employees admitted to wasting about an hour a day or about 12 percent of their work week,12 which adds up to 1 1/2 months of lost productivity for each employee. This fact is staggering given that the loss of 12 percent of an organization's productivity is twice the annual profit for many companies. Given this information, it shouldn't be surprising that a recent study by Sirota Consulting revealed that high morale and morals lead to higher stock prices.13 In fact, the stock prices of 14 high-morale companies increased an average of 16 percent in 2004 while their competitors in the same industries increased by an average of just 6 percent. 

 

The Sirota Consulting study said, "The stock prices of companies with high morale out performed similar companies in the same industry by more than 2 Ω to 1 during 2004 and the stock prices of companies with low morale lagged behind their industry competitors by almost 5 to 1." The study noted that high-morale companies provide fair treatment to its employees, a sense of achievement and pride in their employer, and good productive relationships with fellow employees. The researchers concluded, "Morale is a direct consequence of being treated well by a company, and employees return the 'gift' of good treatment with higher productivity and work quality, lower turnover, a decrease in workers shirking their duties and a superior pool of job applicants. These gains translate directly into higher company profitability." 

 

ETHICS GIVE A COMPANY A BOTTOM-LINE ADVANTAGE 

Your management can do the math and the numbers will sell themselves. What company doesn't want to increase its bottom line two to three times its current earnings without having to slash costs? Answer: every company imaginable, and that includes yours. An inspired ethics program can significantly reduce employee theft of upward to 5 percent and increase productivity upward to 12 percent of the gross revenues. 

 

If your company is like many, it works very hard to earn an additional 1 percent in income.14 How much easier would it be to establish ethics into the product and into the process? How much easier would it be to encourage and promote values that the studies cited in this article have shown are already embraced by your employees, customers, and investors than to create a new product line or product or find new ways to cut manufacturing costs or to streamline business processes? 

 

Think of the windfall of tapping into the ethics of your organization and the benefits of upward to 300 percent increase in profits by reducing both employee theft and unproductive time. 

 

TREMENDOUS RATE OF RETURN 

There is extensive research that demonstrates that an ethics office, working in conjunction with Certified Fraud Examiners, has the potential to generate a tremendous rate of return on its investment. In fact, a well-managed ethics office and anti-fraud program could become the most profitable center in any organization. Studies show that ethics influences the buying decisions of consumers, the employment decisions of the labor force, and the investment decisions of investors so much that an ethical company has an advantage in the marketplace. 

 

You can share this compelling information with management to show that the ethics factor provides a competitive advantage that can be calculated in hard currency. In other words, ethics pays in so many ways. When management supports good ethics it becomes a strategic advantage to any organization or business. 

 

The authors thank Jacki D. Trevino, the program manager for corporate ethics and compliance at Dresser Inc., for assistance in the initial research and support for the premises of this article. 

 

Peter Hughes, Ph.D., CFE, CPA, CCEP, CIA, CITP, is the director of internal audit for the Orange County (OC) elected Board of Supervisors overseeing the county's fraud hotline and investigations, county-wide audit responsibilities, and ethics training for the fifth-largest county in the United States. He also served as the director of internal audit for the Oregon University System, the NASA Jet Propulsion Lab, and the California Institute of Technology. He's a member of the ACFE's Editorial Advisory Committee.   

 

Mary Kaidonis, Ph.D., CPA, is an associate professor of accounting and department head of the University of Wollongong School of Accounting in Australia. She's a recognized leader on corporate governance and ethics for both the private and public sectors. Kaidonis is an original faculty member of the university's renowned Master of Forensic Accounting Program.   

 

 

1 Simon Webley and Elise Moore. "Does Business Ethics Pay?" April 2003. The Institute of Business Ethics.  

 

2 Carlos Grande. "Businesses Behaving Badly, Say Ethics." Financial Times. Feb. 20, 2007.  

 

3 Edelman Building Trust Survey. 2003.  

 

4 Keith McArthur. "Canadians Keener to Trash Talk Bad Firms." Toronto Globe & Mail. March 3, 2007.  

 

5 Environic (now GlobeScan) Corporate Social Responsibility Monitor. 2002. As identified in a presentation by Jacki Trevino, "Fueled by Integrity, Corporate Responsibility," at the 2007 Compliance Academy of the Society of Corporate Compliance and Ethics.  

 

6 2004 Corporate Citizenship Study. Cone Inc.  

 

7 Spuma M. Rao, Ph.D., and J. Brooke Hamilton III, Ph.D. "The Effect of Published Reports of Unethical Conduct on Stock Prices." Journal of Business Ethics. 15:1321-1330. December 1996.  

 

8 Jacki Trevino. "Fueled by Integrity, Corporate Responsibility" message presented at the 2007 Compliance Academy of the Society for Corporate Compliance and Ethics.  

 

9 2004 "Survey on CSR Reputation Effects and MBA Job Choice." Stanford Graduate School of Business.  

 

10 Millie Kresevich. "Using Culture to Cure Theft." Security Management. February 2007. Vol. 51, No. 2, p. 46.  

 

11 Wikipedia: Fortune 1000.  

 

12 Joseph Carroll. "U.S. Workers Say They Waste About an Hour at Work Each Day." Sept. 6, 2007. Gallup News Service. Article written about Gallup's "Annual Work and Education Poll."  

 

13 "High Morale Leads to Higher Stock Prices, Says New Book." April 5, 2005 press release from Wharton School Publishing/Peasons. David Sirota, Louis Mischkind, and Michael Meltzer. "The Enthusiastic Employee: How Companies Profit by Giving Workers What They Want." 2005. Wharton School Publishing/Peasons.  

 

14 Wikipedia: Fortune 1000 Ranking.  

 

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