Establishing an ethical scorecard

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GovernanceConsultants1By Andrés Bernal – Partner at Governance Consultants

 

 

As board adviser, we have been asked many times by our clients, to help them organise and manage the ethical challenges of their organisations. “Something easy, so that it may be supervised… a kind of ethics KPIs,” some have said. However, corporate ethics is obviously a difficult matter to be systematised; given that it depends upon several human subjective factors that are not easy to standardise. Additionally, every business has its own ethical dilemmas and risks due to its ownership structure, the industry it belongs to and the types of decisions it has to make.

GovernanceConsultantsGraphic1Nevertheless, here is our proposal to assist you, as a director or C-level executive, identify and organise the ethical challenges in your organisation. In that regard, the following system would help you visualise the risks your organisation could be facing, establish expectations from your people, define and properly communicate internal controls and, particularly, obtain the information to make timely decisions in order to prevent and control compliance and reputational issues.

It is well known that conflicts of interest and ethics dilemmas are potentially present within all key functions and decisions of modern business. And that all kinds of companies (not only the scandalous types, such as Volkswagen or FIFA) face ethical and conflicts of interests dilemmas, challenges and risks during their daily operations. Consequently, our system – inspired by and adapted from the COSO Cube1 – displays a mechanism to structure a simple system for the identification and mitigation of ethics and conflicts of interests, applicable to any kind of business organisation.

 

ECD dimensions

There are three types of ethical and conflicts of interests dilemmas (ECD) – 1) Potential, 2) Genuine and 3) Apparent – found on the GovernanceConsultantsGraphic2upper side of the Cube (see, right). All three types should be defined and understood in every business.

In the first place, Potential ECD are ethical actions or decisions that may occur in the future or there is a reasonable prevision that they may occur. An example might be when a director knows that a decision that will be heard within a board session will create a conflict of interest, which is especially common in the identification of target companies in mergers and acquisitions.

Secondly, Apparent ECD are the ones in which, mostly due to asymmetry of information, it is clear that the conflict does not exist in reality, but from an external perspective (regulators, media, etc) it can be seen or interpreted as an ethical breach.

Finally, Genuine ECD are problems or conflicts of interest that exist and can affect in ways that are clear and evident to everybody. For example, directors that serve as executives or board members of competing companies.

These three types of ECD can be present in different levels of the organisation (see right side of the Cube). And it is quite common to have different types of ECD depending on the levels or responsibilities of decision makers (e.g. ECD that occur in a trading floor, compared to procurement processes or operational decisions, are completely different).

Every business, due to the type of decisions they have to make and every unit inside the business, all have their own set of ECD. Directors may as well have their own type of specific ECD depending on, for example, which kind of stockholder they are representing, or in which other boards they are acting. Even independent directors may present some types of conflicts of interests. Finally, the company as a whole may have ECD in related-party transactions (contracts or operations with controlling shareholders, subsidiaries and/or business related to the same beneficiary owners).

Finally, the front face of the ECD Cube shows the four key premises for managing ethical challenges in any type of business organisation.

First, the tone at the top managing ECD requires a strong commitment from leadership in order to have a successful ethical model. Secondly, organisations have to implement effective communication tools to increase awareness and create an ethical culture (training/change management strategies); access potential breaches (as whistleblower hotlines) and clear information flows for ECD (within management structures as ethical committees and when the board of director should intervene). Third, businesses have to adopt a clear set of rules (an ethics code or code of conduct for specific activities) to manage certain type of ECD; but also general standards to manage situations and decisions, not explicitly defined in codes. And finally, it is critical to set compliance mechanisms to assure that the defined rules (third component) are followed and respected. This responsibility is usually assigned to internal auditors but it can be a key function of audit/risk committees at board level.

ECD Cube – integrated perspective

Structuring a simple matrix, these three faces of the Cube will present a systematic approach to visualise ECD:

■              Challenges

■              Location of risks

■              Measures/rules

■              Required/expected responses from the whole company

Obviously, to believe that an ethical dilemmas and conflicts of interest model is bullet-proof is not realistic. However, having an organised system to identify, communicate and monitor ethical and compliance risks will facilitate this task and increase your chances to successfully manage increasing challenges in this field. Do not forget that your fiduciary duty as director is to act loyally and diligently to the company and its shareholders. Having an integrated scorecard of how the ethical system of your organisation operates will save your company and, maybe, you personally from a very tough time.

 

 

Carrera 11 # 86-60, Bogotá, Colombia. www.governanceconsultants.com

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