Business Ethics

Written by Vincent Cable MP and published in House Publication on Wed 5th Feb 2003

The recent MORI poll showing that the vast majority of people in the UK regard company bosses as 'over paid' and 'untrustworthy' is a measure of the reputational damage inflicted by 'fat cat' pay controversies, the winding up of company pension schemes and transatlantic scandals revealing accounting deception and misreporting in leading companies.

At the same time, expectations of companies has risen as reflected in the growing movement amongst consumers and investors demanding ethical behaviour towards the environment and the work force at home and overseas.

Few who live and work in western liberal capitalist societies would want to see the 'wild west', 'free for all' capitalism which has prevailed in countries like Nigeria or post soviet Russia where there are few rules and little protection for shareholders, consumers or workers. Such systems are harsh, unequal and not very successful economically. By contrast, successful modern capitalism -- be it of the US, or 'Continental European' or Far Eastern varieties rests on rules and regulation of corporate behaviour. The issue is how much, and how.

The current debate about ethics centres on two issues: the role of managers in relation to owners; and companies in relation to society as a whole.

As to the first there has been a recognition since the days of Adam Smith that managers often have their own agenda, distinct from shareholders, to build corporate empires and to line their own pockets. Indeed, writers like J K Galbraith have treated shareholder capitalism as effectively dead.

The recent excesses in respect of executive pay illustrate the conflicts of interest involved. Many of the 'fat cat' pay awards rewarded failure not corporate success. Awards are rarely market determined - many top managers have risen through the company and would earn only a fraction of their salaries elsewhere. 'Fat cat' pay packages are usually set by other 'fat cats' on remuneration committees, not by the global executive market.

The government was right to require executive packages to be submitted to approval by shareholders; but the results should be binding. And it should bolster shareholder activism by requiring investors, including lazy institutional investors, to publish their voting records (on the Internet).

Given an opportunity, managers will fiddle and conceal true accounts as they did at Enron. Aside from outright fraud, like Maxwells, strong rules are required to ensure transparent, properly audited accounts. Recent government proposals to strengthen the UK regime are generally sensible. I would however go further in order to secure genuinely independent audit by stopping the practice of audit companies offering both lucrative consultancy and audit to the same clients.

Companies have, of course, wider obligations than to their shareholders. Good companies recognise that their staff are their most important resource: ethics and self interest combine to promote employee consultation, training, reasonable job security and safe working conditions. For those who fail to meet minimum standards regulation is required. Clearly, a sensible balance has to be struck between regulatory effectiveness and costs. In some cases there is over regulation, notably in the working time legislation; but there are other areas - worker consultation in the case of major decisions; investigation and prosecution of serious industrial accidents - where the balance tips the other way.

Similarly, enlightened, ethical companies will build a reputation for serving their customers fairly. But unethical behaviour is rampant in some sectors, particularly financial services, where widespread misselling of complex products - pensions, endowments, home reversion policies - has led to growing, and understandable, pressure for regulation. There are so many abuses in some markets that a general 'duty to trade fairly' is now widely perceived to be necessary.

Superimposed on regulatory standards, there are now growing demands that companies subscribe to corporate social responsibility objectives. Some companies have long made a virtue of business ethics - the Quaker companies most notably. And the importance to shareholder value of brand integrity and reputation is now increasingly understood in modern corporations. Firms in industries which pose ethical problems - tobacco or arms - or which have been accused of major environmental or social failings know that they run the gauntlet of ethical investors and consumers and public interest lawyers.

What is more controversial is the demand for corporate social and environmental responsibility to be formalised in reporting and regulatory systems. Again the issue is one of balance. Improved and consistent reporting on CSR will help inform investment decisions. But very complex reporting requirements and conflicting obligations to multiple stakeholders will undermine ethical capitalism.