Ethical dilemmas demand moral leadership

Source: Management Scope (June 2017); Interview: Arnold Croiset van Uchelen – Author: Marike van Zanten

How much integrity do CEOs have? Are the men and women at the top of the business community eligible for the honorary title of Chief Ethics Officer? Or is there frequently a Chief Evil Officer hiding behind a CEO’s job description? This is a fitting theme for a double interview with Marry de Gaay Fortman, Attorney/Partner at the law firm Houthoff Buruma (one of De Gaay Fortman’s specialities is governance) and experienced Supervisory Board Member at De Nederlandsche Bank and KLM, and Xavier Baeten, Professor of Reward Management & Sustainability at Vlerick Business School. De Gaay Fortman and Baeten have a highly informed vision on ethical issues and the ins and outs of corporate life which takes pitfalls and human weaknesses into account.

The interview is conducted in a fitting location: in the middle of Amsterdam’s Zuidas business district, the place with the highest density of boardrooms per square kilometre in the whole of the Netherlands. There’s no doubt that in every one of the surrounding office blocks, someone will at some point have been staring desperately outside, scanning the sky for the answer to the ethical questions with which every organisation is inevitably confronted. Hopefully this will not only have been the CEO, but also members of his or her management team or supervisory board. Because if one thing is clear from the dialogue between De Gaay Fortman and Baeten, it is that an (un)ethical set-up is not only the personal choice between good and evil made by a single man or woman, but above all a product of the diversity and dynamic in teams, the candid conversations that people may or may not have with one another, and the systems that they have together put in place and are sustaining.

The reason for and premise of the double interview is the study in which Baeten asked 950 Dutch and Belgian CEOs about their motivations and integrity and then assessed them on these (study undertaken in partnership with the Belgian-Dutch networking organisation Business Leaders). The results, which were presented earlier in this magazine, were striking: 69 per cent of interviewees deserved the label ‘ethical’ CEO, meaning that 31 per cent did not: it emerged that a third of CEOs were pushing the boundaries in the case studies they had been presented with, and in some cases (no doubt inadvertently…) breaking the law. Moreover, in the group of ‘ethical CEOs’ there were a relatively high number of women and over-45s, and more Dutch people than Belgians. The type of company played a role (family firms generally behaved less ethically than listed companies), as did the remuneration structure: the ethical CEOs are less likely to have shares and their remuneration is not solely dependent on financial KPIs. Finally, the governance model turned out to be important: CEOs who were accountable to a supervisory board behaved in a significantly more ethical way than their counterparts without overseers.

Women and over-45s were apparently more ethical than men and their younger counterparts. But are they not simply more skilled at giving politically correct answers?

Baeten: ‘To check this, we presented the CEOs with two practical scenarios: would you work with a supplier that is 25% cheaper than the others, but that is none too particular about human rights and working conditions? And: what should you do if one of your best salespeople turns out to be paying bribes to clients? From the combination of the scores for both cases, it became apparent which CEOs deserved the ‘ethical’ label. Amongst these were a relatively large number of women. For example, in the case with the supplier, men were more often inclined to work with the dubious party, who they either did not tackle or only half-heartedly tackled about their behaviour. Women more often made decisions that were consistent and showed integrity. Young people were also more likely to put the company’s interest above integrity. I also notice the latter phenomenon in the ethics course that I deliver once a year for a group of between three and four hundred people, ranging from young professionals aged 22 to experienced managers. Young people are more often focused solely on the company or their careers, and tend to show a greater preparedness to set aside their own norms and values for this. That is very worrying.’

De Gaay Fortman: ‘On the other hand, you see that purpose and meaning are actually becoming increasingly important for the younger generation, and this at least is a source of hope. As well as the individual and the company, you can also discern a third dimension: the system. If boundaries have been crossed, people often say: the organisation has made mistakes, but I have integrity. They make a distinction between the environment of which they are a part and themselves. They often fail to see their own responsibility within this: it is as though it is going on beyond them personally. That’s why it is so important that there should be a willingness in the boardroom and in the rest of the organisation to candidly discuss ethical dilemmas. It is only at this point that it really comes home to them, and people ask themselves: what do I actually think about this myself and how should I react to it?’

So a culture of openness and debate is more important than regulations and codes of conduct to enforce integrity? 

Baeten: ‘Regulations do not inspire people to behave with integrity. It is more effective to appeal to people’s intrinsic motivation to act with integrity and to their own norms and values. Openly sharing dilemmas can help with this. For example, during a training session for intermediaries in the insurance sector, a spontaneous discussion arose about how to handle dishonest damage claims by customers. Some intermediaries show these customers the door, while others do not. It is good to break open the taboo around these kinds of difficult questions and to debate ethical questions more often.’

De Gaay Fortman: ‘Again, regulation can play an important role in this. For example, the new corporate governance code aims explicitly to stimulate this debate in the boardroom, by focusing on themes such as tone at the top, culture, long-term value creation and risk management. And to follow on from that last point: in the boardroom and in the organisation as a whole, we must make one another more aware of the risks of the choices that we are making. Decisions that are beneficial to the company in the short term can, in the long term, have an adverse impact on value creation and culture, or even result in serious reputational damage. We must therefore become more adept at recognising the long-term consequences of our thoughts and actions, and at calling each other to account. This is inconvenient, because you want to be able to resolve issues quickly, but it is necessary.’

What role is played by diversity in a wider sense when conducting the ethical debate: does it lead to greater openness? Or does it actually have a paralysing effect, because management and supervisory board members only feel free to share personal dilemmas with a homogenous group of people?

Baeten: ‘Research has shown that diversity leads to a richer and more interesting debate, provided that there is sufficient mutual trust. Only then do people dare to be open. There is a key role for the chairman in this: he or she must also create trust in a heterogeneous group and ensure that everyone has a chance to speak, that every contribution is valued and that divergent opinions are listened to.’

De Gaay Fortman: ‘The corporate governance code says that boards of directors and supervisory boards must be diversely composed to ensure more balanced decision-making, a healthier culture and a more open discussion. Yet there is still a great deal of resistance in boards to people of a different gender, background or nationality. People often feel uncomfortable and less secure in a heterogeneous group, because they cannot read other members of the group straight away. Funnily enough, resistance falls away completely in international boards. For example, at Amref, I sat on the board as a Dutch woman alongside fellow Europeans, Americans and Africans. The collaboration was not dominated by unwritten rules or presuppositions, but by principles and professional values. This makes the discussion much easier. So the first thing we need to achieve is to overcome boardroom resistance to diversity.’

Baeten: ‘This also applies to the remuneration committees within the supervisory boards: greater diversity in their composition, and the absence of a cliquish atmosphere with people who have all been to the same business school, will ultimately lead to better decision-making about remuneration.’

What role do remuneration systems play in ethics?

Baeten: ‘Bonus systems that are entirely based on financial KPIs can lead to short-termism and unethical behaviour. That is one preliminary finding of our ongoing research into the remuneration policies of companies that create sustainable value for shareholders. If variable pay based on financial performance criteria constitutes a large proportion of the remuneration, this means that you are one-sidedly stimulating turnover and profit maximisation. What gets rewarded gets done. Therefore you must also apply non-financial criteria in order to steer things in a more balanced way. To reinforce the focus on the long term, there have also now been calls for a basic income, with a share package that may only be cashed in many years after leaving the company or even only upon retirement. This also represents a radical simplification.’

De Gaay Fortman: ‘You could link the awarding of a variable remuneration to criteria such as behaviour and leadership, but could also consider other forms of reward, such as appreciation, collegiality, openness and integrity. This pushes things in the right direction.’

In recent years, there has also been a great deal of social commotion about the level of top salaries. Is the remuneration of directors actually an ethical question? Or is it merely a matter for the market to determine?

Baeten: ‘Here too, the parties involved are imprisoned in the system. Our research shows that directors are not primarily motivated by money. The CEOs of the best-performing companies are often paid no more than those of other companies. Many supervisory board members would also like to bring about change in the remuneration culture at the top. However, they come up against the dictatorship of the market: the scarcity of good directors drives remuneration up. Furthermore, remuneration systems have become incredibly complex and opaque. Supervisory board members should dare to break through this impasse around remuneration, but this takes courage. For shareholders, the level of the reward is often not an issue: if a company offers a sufficient rate of return, investors do not really care if the top man makes an extra million. Proxy advisory services sometimes even demand that supervisory board members conform to the prevailing remuneration standards. However, socially that extra million makes a substantial difference and is seen as an ethical matter. The corporate governance code tries to turn around the upward remuneration spiral with demands for transparency about the internal remuneration structure: the relationship between the remuneration at the top versus the rest of the organisation. But this again leads to the outsourcing of the lowest paid staff, in order to improve the pay ratio. That cannot be the intention.’

De Gaay Fortman: ‘No, in that case it has counterproductive effect. Directors who outsource the bottom layer of staff during a reorganisation with the idea in the back of their minds that the pay ratio will immediately look better: that is truly unethical. As is establishing the company in a country where remuneration practices are the most favourable. Ethical remuneration policy has two principles: which remuneration instruments are functional and in line with the desired behaviour? And: is the remuneration at a decent level or not? When Jan Hommen was still the top man at ING, he anticipated that his bonus would lead to a social debate, in light of the support that ING had received from the government and customers’ broken trust. For those reasons, he wanted to forgo it, but the supervisory board members acted as the employer and pushed it through. Hommen turned out to be right: society felt that a bonus sent the wrong signal.’

Should top people also be selected on the basis of their moral fibre? Should the suitability test for directors and supervisory board members in the financial sector be expanded to all listed companies, for example? Or do we already have too much state supervision?

Baeten: ‘Supervisory board members already focus too heavily on the person, and not enough on the necessary balance in the team. They look in too Cartesian a way at the discipline that the profile suggests they need, and too little at the role or the behavioural complement that the team needs. Moreover, succession planning in many supervisory boards is still insufficiently professional: they start too late, the search process comes under pressure, and then often there is simply too little time for out-of-the-box thinking. If you are searching for a key, then it’s no use searching only in well-lit places, because that’s not usually where you’ll find it.’

De Gaay Fortman: ‘It is therefore also simply a question of more professional governance. Starting with the succession in good time, integrating culture and behaviour into the appointments policy for good checks and balances, and a more robust testing of candidates’ suitability. Sometimes you see people of whom you are aware that they have not performed well in a certain function simply resurfacing elsewhere in similar positions. It is therefore important to collect old-fashioned, thorough references. You do not need a suitability test carried out by a third party for this; supervisory board members can do it themselves. Moreover, it is far from easy to determine what exactly the ethical social norms are. There is no definition of these, so what exactly should you make of this? Furthermore, it is a moving target: something which is regarded as socially proper today, may be improper tomorrow. This is also true of ethical dilemmas. At the beginning of this century, the bribes that Dutch companies paid abroad were apparently simply tax deductible. Since then, policy surrounding bribery and corruption has been tightened up. Therefore as a supervisory board member, you need to take a good look outside, and once again the message is: discuss it with one another. Also ensure that this discussion is recorded in the minutes, so that at a later date, whether or not a judge has been involved, the information about the grounds on which the decision was taken at the time can be retrieved. You should also include it in the supervisory boards report in the annual report. There is a huge responsibility on boards to deal with social issues and to communicate about them.’
Government and politics, which traditionally acted as reinforcers of morality, are coming under increasing populist pressure. To what extent do you see a shift towards businesses as reinforcers of morality?

De Gaay Fortman: ‘It is precisely large, listed companies that are currently actively seeking out social debate and showing moral leadership. If I look at my experience on my supervisory boards, then I certainly recognise the findings of Xavier’s research, which shows that large businesses do this to a greater extent than public bodies. A few years ago, CEOs still fell short in terms of taking up their social responsibility. They were afraid that this would damage the share price. These days, businesses can no longer evade society’s expectations. This does lead to tension with shareholders: they want to know, for example, how sustainability relates to returns.’

Baeten: ‘That also depends on the type of shareholder: I can imagine that some Anglo-Saxon institutional investors might regard Paul Polman as naive, whilst Dutch investors have a more long-term vision, and sometimes even take up an active role with respect to sustainability. Consumers too should be able to take on a more active role when it comes to unethical behaviour by companies. In terms of car sales, Volkswagen has had a highly successful year, despite their cheating software. It seems that regardless of all the scandals, we are still unaccustomed to discussing ethical choices with one another, in either the boardroom, or in society as a whole. Over the coming years, we shall need to be far more active in kick-starting that debate: not only in business, but also in upbringing, education and management training courses.’

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