Sniffing it Out

The first Virginia governor I worked for directly was John Dalton, who was fond of saying that his personal gauge for ethically challenged behavior was the smell test, i.e., did any proposed action (and its follow-on implications) have the odor of appropriateness. Philosophical theories provide the bases for most useful practical decision approaches and aids, although a majority of seasoned executives are unaware of how and why this is so. Whatever the foundation of the phenomena may be, most experienced directors, executives, professional accountants (and governors) appear to have developed tests and commonly used rules of thumb that can be used to assess the ethicality of decisions on a preliminary basis.

If these preliminary tests give rise to concerns, most think a more thorough analysis should be performed. It is often appropriate (and quite common in practice) for subordinate managers and other employees to be asked to check a proposed decision in a quick, preliminary manner to see if an additional full-blown ethical or practicality analysis is required. These quick tests are often referred to as sniff tests. If any of these quick tests are negative, employees are asked to seek out someone like the corporate counsel or an ethics officer (if there is one) for consultation, or to personally perform a full-blown analysis of the proposed action. This analysis is usually retained, and perhaps even reviewed by upper management.

Some of the more common sniff tests employed by managers with whom I’ve worked are:

–Would I be comfortable if this action or decision were to appear on the front page of a national newspaper tomorrow morning?
Will I be proud of this decision?
Will my mother and father be proud of this decision?
Is this action or decision in accord with the corporation’s mission and code?
Does this feel right to me?

Unfortunately, although sniff tests and commonly used ethical rules of thumb are based on ethical principles as popularly conceived and are often useful, they rarely, by themselves, represent anything approaching a comprehensive examination of the confronting decision and therefore can leave the individuals and organization(s) involved vulnerable to making a challengeable choice. For this reason, experts advise that more comprehensive techniques of evaluation should be employed whenever a proposed decision is questionable or likely to have significant consequences. Analysis of specific sniff tests and the related heuristics reveals that they usually focus on a fraction of the comprehensive set of criteria that more complete forms of analysis examine.

Traditionally, an accepted business school case approach to the assessment of a corporate decision and the resulting action has been to evaluate the end results or consequences of the action. To most businesspeople, this evaluation has traditionally been based on the decision’s impact on the interests of the company’s owners or shareholders.

Usually these impacts have been measured in terms of the profit or loss involved, because net profit has been the measure of well-being that shareholders have wanted to maximize. This traditional view of corporate accountability has been modified over the last two decades in two ways. First, the assumption that all shareholders want to maximize only short-term profit appears to represent too narrow a focus. Second, the rights and claims of many non-shareholder groups, such as employees, consumers/clients, suppliers, lenders, environmentalists, host communities, and governments that have a stake or interest in the outcome of the decision, or in the company itself, are being accorded an increased status in corporate decision making.

Modern corporations are increasingly declaring that they are holding themselves self -accountable to shareholders and to non-shareholder groups alike, both of which form the set of stakeholders to which the company pledges to respond. It has become evident (look at the Enron example) that a company cannot reach its full potential, and may even perish, if it loses the support of even one of a select set of its stakeholders known as primary stakeholders.

The assumption of a monolithic shareholder group interested only in short-term profit is undergoing modification primarily because modem corporations are finding their shareholders are to an increasing degree made up of persons and institutional investors who are interested in longer-term time horizons and in how ethically individual businesses are conducted. The latter, who are referred to as ethical investors, apply two screens to investments: Do the investee companies make a profit in excess of appropriate hurdle rates, and do they strive to earn that profit in a demonstrably ethical manner?

Because of the size of the shareholdings of mutual and pension funds, and of other types of institutional investors involved, corporate directors and executives have found that the wishes of ethical investors can be ignored only at their peril. Ethical investors have developed informal and formal networks through which they inform themselves about corporate activity, decide how to vote proxies, and how to approach boards of directors to get them to pay attention to their concerns in such areas as environmental protection, excessive executive compensation, and human rights activities in specific countries and regions. Ethical investors as well as other stakeholder groups, tend to be increasingly unwilling to squeeze the last ounce of profit out of the current year if it means damaging the environment or the privacy rights of other stakeholders. They believe in managing the corporation on a broader basis than short-term profit only. Usually the maximization of profit in a longer than one-year time frame requires harmonious relationships with most stakeholder groups based on the recognition of the interests of those groups.

A negative public relations experience can be a significant and embarrassing price to pay for a decision making process that fails to take the. wishes of stakeholder groups into account. Whether or not special interest groups of private citizens are also shareholders, their capacity to make corporations accountable through social media is evident and growing. The farsighted executive and director will want these concerns taken into account before offended stakeholders have to remind them.

Taking the concerns or interests of stakeholders into account when making decisions, by considering the potential impact of decisions on each stakeholder, is therefore a wise practice if executives want to maintain stakeholder support. However, the multiplicity of stakeholders and stakeholder groups makes this a complex task. To simplify the process, it is desirable to identify and consider a set of commonly held or fundamental stakeholder interests to help focus analyses and decision making on ethical dimensions; stakeholder interests such as the following:

1.Their interest(s) should be better off as a result of the decision.
2. The decision should result in a fair distribution of benefits and burdens.
3. The decision should not offend any of the rights of any stakeholder, including the decision maker, and ..
4. The resulting behavior should demonstrate duties owed as virtuously as expected.

To some extent, these fundamental interests have to be tempered by the realities facing decision makers. For example, although a proposed decision should maximize the betterment of all stakeholders, trade-offs often have to be made between stakeholders’ interests. Consequently, the incurrence of pollution control costs may be counter to the interests of short-term profits that are of interest to some current shareholders and managers. Similarly, there are times when all stakeholders will find a decision acceptable even though one or more of them, or the groups they represent, may be worse off as a result.

In recognition of the requirement for trade-offs and for the understanding that a decision can advance the well-being of all stakeholders as a group, even if some individuals are personally worse off, this fundamental interest should be modified to focus on the well-being of stakeholders rather than only on their betterment. This modification represents a shift from utilitarianism to consequentialism. Once the focus on betterment is relaxed to shift to well-being, the need to analyze the impact of a decision in terms of all four fundamental interests becomes apparent. It is possible, for example, to find that a proposed decision may produce an overall benefit, but the distribution of the burden of producing that decision may be so debilitating to the interests of one or more stakeholder groups that it may be considered grossly unfair. Alternatively, a decision may result in an overall net benefit and be fair, but may offend the rights of a stakeholder and therefore be considered not right. For example, deciding not to recall a marginally flawed product may be cost effective, but would not be considered to be right if users could be seriously injured. Similarly, a decision that does not demonstrate the character, integrity, or courage expected will be considered ethically suspect by stakeholders.

A professional CFE can use an assessment of our client organization’s stakeholder ethical concerns in making pro-active recommendations about fraud detection and prevention strategies and in conducting investigations and should be ready to prepare or assist in such assessments for employers or clients just as they currently do in other fraud deterrence related business processes.

Although many hard-numbers-oriented investigators will be wary of becoming involved with the soft risk assessment of management’s tone-at-the-top ethically shaped decisions, they should bear in mind that the world is changing to put a much higher value on the quality and impact of management’s whole governance structure, the posture of which cannot failure to negatively or positively affect the design of the client’s fraud control and prevention programs.

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