Why Be an Ethical Company? They're Stronger and Last Longer

With everyone still buzzing about the outrageous bonuses Wall Street continues to pay, it seems like now might be a good time to write a column about ethics. No, I don't want to write another article calling greedy bankers unethical. Plenty of pundits have already done that. Rather, I'd like to speculate on why some executives are so greedy, the role it played in their downfall, and how an inability to change organizational mindsets will probably lead to future banking crises. I'd also like to go beyond Wall Street and examine ethics in the broader context of American business.

I was privileged to hear Harvard Business School professor Michael Beer at a recent meeting hosted by the Yale CEO Institute. Beer lectured CEOs on building companies that can perform at high levels for extended periods. He started with some interesting statistics on the root causes of the worst financial crisis since the Great Depression:

Of the original Forbes 100 in 1917, 61 ceased to exist by 1987. Of the remaining 39, only 18 stayed in the top 100, and their return was 20% less than the overall market during the period from 1917 through 1987.

Of companies in the original Standard & Poor's 500-stock index in 1957, only 74 remained in 1997; of these, only 12 outperformed the S&P 500 in the period from 1957 through 1998.

The average CEO tenure in the U.S. is 4.2 years, less than half the 10.5-year average in 1990.

Beer, author of High Commitment, High Performance, a book on business ethics recently published by Josey-Bass, posited three core reasons why Wall Street failed so badly in the fall of 2008: The firms lacked a higher purpose, lacked a clear strategy, and mismanaged their risk.

I would have difficulty arguing that many Wall Street firms had ever had a higher purpose than making money for themselves first and their customers second. But that's clearly not true for all Wall Street companies. Charles Schwab & Co. (SCHW) has largely avoided the huge fallout. So has US Bancorp (USB). A quality both of these companies share is a laser-like focus on customer service and on honesty and transparency. This comes from their cultures.

Neither company touched the subprime mortgage securitization market, because they saw it as risky and simply not the kind of business that served the company's long-term interests. I'd wager, as well, that these companies didn't feel comfortable asking their employees to sell unethical mortgages to customers, a practice undertaken by many subsidiaries of the big Wall Street investment banks and large bank-holding companies.

In other words, these companies did have a sense of higher purpose. That sense filtered down into strategy and risk management. Schwab has always had DNA as a no-frills financial-services house providing straightforward products and stellar customer service. US Bancorp has always been a straight shooter with a particularly strong practice focused on high-net-worth individuals. Both have an extremely strong sense of responsibility to their customers. And it shows. Not surprisingly, both companies have weathered this crisis particularly well and are poised to excel in the post-crisis years.

bullied by a maniacal focus on the fast buckAnother key failing Beer discussed was the inability of actors inside the large, failing banks to speak truth to power. Key players inside the banks felt intimidated by superiors; the internal voice of conscience and purpose of these institutions was silenced by a maniacal focus on short-term profits and whatever scheme would bring them in.

The silencing of employees who sought to challenge strategy and risk-management practices likely also undermined the banks' moral authority and emboldened those who already felt inclined to do the wrong thing. With a muted internal voice, these organizations lacked a moral compass. As a result, they drove off a cliff with astonishing speed. And, for the most part, they still haven't recovered. Bank of America (BAC) and Citigroup (C) are still considered technically insolvent by many hedge fund managers and financial analysts.

Unfortunately, these organizations still appear to lack that internal voice. Handing out massive bonuses based on short-term performance when U.S. unemployment is at nearly 10% and the real unemployment rate is at closer to 16% can only be taken as a sign that greed remains their driving force. With this continued focus on short-term pay and, by extension, paper profits, these firms are destined to repeat their sad history. Short-term focus is very hard to reconcile with any long-term strategy or sense of purpose beyond simply making money. More bluntly, short-term thinking doesn't reconcile with good ethics.

For some better examples, let's look outside banking. A number of companies, according to Beer, either started out with or developed an internal voice and a moral compass. That voice has played a key role in keeping these companies on top. The list of these companies reads like a Who's Who of American business' management rock stars. Some, such as Goldman Sachs (GS), have been discredited. But the majority, including Cisco Systems (CSCO), Southwest Airlines (LUV), and Costco Wholesale (COST), among others, have sailed through this crisis with flying colors.

Costco has the last laughWitness Costco. Wall Street analysts have long chastised Costco's management for paying high wages and keeping employees around for a long time, resulting in higher benefits costs. Costco CEO Jim Sinegal has responded by saying that keeping good employees is strategic for the long-term success and growth of Costco. To date, hehas backed up this assertion with per-employee sales that are considerably higher than those found at key rivals such as Target (TGT) and Wal-Mart (WMT).

Sinegal asks his employees refer to him as "Jim, the CEO." And for a power CEO, Sinegal gets a compensation package that would reduce many midlevel investment bankers to tears, with salary and bonus of less than $800,000. (Sinegal gets a much larger amount in options on shares but still ranks low in terms of total pay compared with executives running companies of equivalent size). The culture of the company flows downward from Sinegal and his focus on employees and, by extension, customers. As a result, Costco chalks up considerable improvements in its product mix and sales due to alert employees in the warehouses who are happy to feed the latest information from the field up the chain to headquarters.

And customers love Costco's paradoxical mix of high-end items in bulk (organic canned tomatoes, anyone?) and rock-bottom prices. Customer service at the stores is phenomenal and fast. And Costco continues to expand, both in number of warehouses and in products and services for business and consumer customers.

The moral here is fairly simple: When a company's ethical compass is pointing true north, everything else falls into line. This isn't to say that companies with great ethics don't fail. But it does seem to indicate that companies without good ethics are far more likely to fail due to their inability to sustain or hear an inner voice to guide them through the dark times to the light.

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