Chief executives must take the lead in articulating their vision of a company that meets its targets while following the highest ethical standards, says Ben Heineman

Global capitalism must candidly face a fundamental problem of integrity: at the very heart of high performance lie fundamental forces that, if left unconstrained, cause corporate corruption.

Top-performing companies apply relentless internal pressure on their people to hit basic financial goals for net income, cashflow and stock price. Other targets, too, may be critically important: achieving specific returns on investment, equity or assets; hitting sales or service goals; meeting product development or product launch schedules; and attaining productivity increases, to name a few.

Pressure begets more pressure. “Stretch targets” may put numbers on steroids. The explicit “nice to hit” target becomes an implicit “must do”.

Personal incentives are driven by “making the numbers” and therefore create ubiquitous temptations. Employees at all levels may feel that their bonuses and promotions – and perhaps even their job security – depend on falsifying accounts, cutting corners, skipping key process steps, or worse.

Far-flung global enterprises face external pressures, which also create ever-present and illicit temptations. Many non-US markets – from Russia to Brazil, from the Middle East to Asia – suffer from a weak rule of law, endemic corruption, and pervasive conflicts of interest. Yet these same markets are now a critical source of growth for global corporations. Whether that growth is organic or comes through acquisitions, new employees are predominantly local nationals. Not surprisingly, these individuals often come from cultural or business backgrounds that tolerate practices intolerable to a transnational company, such as bribes, shoddy accounting, and channelling business to family members.

In most of those nations, moreover, dealing with government is a major element of doing business because the state defines markets, procures goods and services, taxes income, and makes countless other decisions that decisively affect firm performance. Official extortion and misappropriation are clear and present dangers in places where the rule of law is tenuous at best.

Local customers, too, may request that companies bend or break rules to facilitate the customers’ own private- or public-sector relationships. Similarly, using third-party distribution may be a local or regional necessity, but it tends to raise a host of legal and ethical issues. And with the dramatic enhancement of global supply chains, global companies must increasingly worry about the financial, legal and ethical practices of their sourcing partners.

Unconstrained, these external pressures, too, can corrupt capitalism. And the mix of these external pressures with the firm’s own internal pressures can be an especially toxic brew.

Fusing performance and integrity

At GE, I lived with these pressures and tensions for nearly 20 years. My basic conclusion: I believe that the chief executive’s core task is to channel the financial pressures properly, by fusing high performance with high integrity: in other words, to develop systems, processes, and practices that are built on clearly articulated principles, and are based ultimately on a performance-with-integrity culture.

What characterises this culture? It motivates by values, norms, incentives, penalties and transparent processes. It doesn’t just seek to keep people from misbehaving through threats of discovery and punishment. It also seeks to develop and reward employees who recognise, value and exemplify integrity. By combining the carrot and the stick, it drives demanding performance built on unyielding integrity, both in small companies and across great global enterprises.

The governance debate of the past ten years has largely missed this fundamental point: only the chief executive can affirmatively create the culture and drive fusion of high performance with high integrity. Yes, regulators, outside gatekeepers, and directors all play their important roles, mainly by providing guidelines and checks and balances. But the chief executive and senior leadership make it happen.

To understand why this is so, let’s revisit some basics. Corporate governance has three dimensions:

· the relationship between the shareholders and the company;
· the relationship between the directors and top company leaders; and
· the relationship between those leaders and the employees.

The first of these relates to a core governance issue: what should the respective powers of the shareholders, the board and company leaders be when it comes to setting commercial strategies and attaining financial performance? Although this is not my main focus, clearly the short-term economic pressures from different types of activist shareholders increase integrity risks.

The second core governance issue delineates the respective roles and responsibilities of company leaders and the board in attaining high performance with high integrity. Fuelled by the scandals that increasingly are captured under the umbrella term “Enron”, this second governance issue rocketed to prominence at the turn of the century.

Because many of the improprieties of Enron flowed from top company leadership – the hall of shame populated by, among others, Lay, Skilling, Fastow, Ebbers, Kozlowski and Rigas – the focus of many post-Enron reforms has been to increase the roles and responsibilities of the board and its committees in overseeing the chief executive.

Indeed, a full-blown governance industry focused on the role of the director has emerged in academia, think tanks, watchdog groups, the investor community, advocacy groups, and the media. Yes, the board has an absolutely critical role to play in choosing, compensating, and evaluating the chief executive and other top company leadership. And yes, it plays an essential role in setting the corporate agenda, identifying the corporation’s critical risks and opportunities, and providing advice and oversight for those core strategic issues.

Just as important, as I see it, the board needs to create a new “spec” for chief executive selection that includes the desire, ability and experience to fuse performance with integrity. And the board has to develop chief executive compensation plans that don’t just reward performance, but reward performance with integrity.

But despite all the scandals, debates, and reforms, one of the most basic facts of life about corporations remains unchanged: the board cannot manage or lead the company. That remains the job of the chief executive and the corporation’s other key officers.

A board of directors that meets eight or ten times a year simply cannot do the heavy lifting – the grinding, complex, day-in, day-out, hands-on work. It’s not even a close call: the most pervasive, powerful and affirmative integrity-related governance issues are the responsibility of the senior leadership from the chief executive down. How can they drive a demanding performance-with-integrity culture throughout the corporation? The integrity landmines that can blow up in the firm’s face are not buried in a remote office; instead they are to be found in all areas of the company.

Many corporations today are seeking to achieve performance with integrity at an operational level. Their chief executives must lead on the outside, not just the inside. They must help shift the centre of the public governance debate from its current obsessive focus on board responsibilities to its least discussed and most important dimension: governance on the front lines.

The benefits of avoiding risk

In a rapidly changing world, one fundamental benefit of fusing high performance with high integrity is reducing unwanted risk and cost.

I was at GE from 1987 to 2005. In roughly that same period, and particularly in this decade, there was a sea change in legal and regulatory trends in the United States and, increasingly, around the world. Previously, the chief executive who paraded a confident leadership style and accelerated financial results won widespread trust and admiration. Not so today. For a whole host of reasons ranging from scandals to globalisation, the world is a much more sceptical, critical, and adversarial place.

Consider, for example, the “legalisation” of accounting rules in the wake of the financial-engineering scandals. Of course, outright fraud or reckless accounting actions should be punished. But, good-faith accounting interpretations that several decades ago would have been the subject of a conversation with the office of the SEC’s chief accountant are now the focus of an informal (or formal) inquiry from the SEC’s beefed- up enforcement division – and may result in negotiated consent decrees.

This is symbolic of broader regulatory trends. A decade ago, regulators would usually create new rules, or clarify ambiguous ones, through administrative rule making. This process sought broad input from the regulated and affected parties, and had a prospective effect: nobody looked backwards. Today, impatient regulators try to change the law through enforcement cases against individual companies – and are inclined to impose legal sanctions retroactively for corporate actions taken in good faith.

By any measure, this is a big change. The US justice department and other federal regulatory agencies, seeking to criminalise regulatory statutes, jockey for position with state attorney-generals. Meanwhile, in addition to enhanced government enforcement across a range of traditional issues – topics such as anti-trust, anti-bribery and securities law – regulators are expanding enforcement on newer issues such as privacy, consumer protection, money laundering and export licensing. At the same time, enforcement is burgeoning elsewhere, in both the developed and developing worlds. Finally, with trust eroded by scandal, the media – encouraged by a dramatic rise in watchdog groups and other non-governmental organisations – today make any consequential corporate failing front-page news.

Debates can rage about whether or not these policy and media shifts are a good thing. But, they’re out there, and they pose accelerating threats to the economic health and reputation of corporations.

Any business leader who has been through an intense government investigation – myself included – can testify to its huge and negative impact. Enormous amounts of time, effort, and treasure are consumed. Key executives come to view each other with distrust. The chief executive and other leaders get distracted, spending weeks and even months ensuring that the company’s response is complete and correct. Typically, problems compound themselves, as other regulators and private litigants, not just in the US, launch parallel proceedings. Suddenly, the company faces a three-, four-, or five-front war.

If you get caught

What happens when there is not just smoke, but also fire? The corporate consequences can range from significant to dire. In the wake of egregious integrity violations, companies may be forced into bankruptcy or even collapse. The hit to the bottom line can be enormous. As recently as a decade ago, a fine or penalty or settlement in the $100 million to $200 million range was considered large; today, comparable events can reach into the billions.

The individual consequences, too, range from the humiliating to the catastrophic. In the last decade, many once-celebrated chief executives have lost their jobs (or left ahead of schedule) due to integrity shortfalls: Hank Greenberg at AIG (the failure: company accounting); Frank Raines at Fannie Mae (company accounting); Peter Dolan at Bristol-Meyers Squibb (failure to inform the board); Phil Condit (procurement scandals) and Henry Stonecipher (personal behaviour) at Boeing; John Brown at BP (lack of safety culture); and Klaus Kleinfield at Siemens (widespread bribes), among others. Others, including those “hall of shame” members mentioned earlier, have, of course, received stiff jail sentences and have been hit with large financial fines and penalties.

But other consequences growing out of a major integrity lapse can have an even greater long-term impact. Business relationships are put through the grinder. A corporate reputation built over years or decades gets shredded overnight. The market cap tanks. Eventually, if the damage is deep enough, all stakeholders are hurt. Employees lose their jobs, retirees lose their pensions, shareholders lose their equity value, creditors swallow bad debts, customers lose a supplier, suppliers lose a buyer, and communities suffer in a variety of ways from lost or reduced business.

The next thing that happens, not surprisingly, is that a cry goes up for new laws and regulations to keep this from ever happening again. Corporate efforts at self-policing are ignored, mainly because they appear belated, half-hearted, or hypocritical. Suddenly, the policy-making apparatus lurches forwards, often with uncertain or undesirable results.

My main point is that the chief executive’s job today is far different to how it was 20 or even ten years ago. The changes have come from almost every direction: in the form of laws, regulation, enforcement, stakeholder activism, stakeholder expectations and media scrutiny, to name just a few. As a result, business leaders must work much harder, and more effectively, to navigate the shoals of a more hostile, less forgiving environment – even as they attempt to succeed in a hyper-competitive global economy.

The lesson seems clear. To avoid unwanted risk and cost for their companies, their stakeholders, and themselves, today’s chief executives must fuse high performance with high integrity.

So far, I’ve accentuated the negative. But fusing high performance with high integrity also fosters “corporate citizenship”, which – when properly conceived – creates affirmative benefits inside the company, in the marketplace and in broader society.

As I define it, corporate citizenship has three interrelated dimensions:

· strong and sustained economic performance;
· robust and unwavering adherence to the spirit and letter of the relevant financial and legal rules; and
· the establishment of, and adherence to, binding global standards – extending beyond the requirements of formal rules – which are in the company’s enlightened self-interest because they promote its core values, enhance its reputation, and advance its long-term economic health.

Affirmative benefits

High integrity – the adherence to formal requirements and the voluntary commitment to ethical standards and values – yields many affirmative benefits. Inside the company, it helps attract and retain top talent. It empowers employees to speak up on both performance and integrity concerns. It contributes to meritocratic employment practices. It helps create a culture of alignment between personal values and company values, thus improving morale, pride in the company and productivity.

In the marketplace, it enhances the brand, contributes to the integrity of products and services, differentiates the corporation from its competitors, minimises customer complaints and addresses investor concerns. By so doing, it advances company growth.

In broader society, it enhances the company’s reputation, which in turn provides credibility in public policy debates; enables respectful relationships with regulators; generates positive media, which in turn augments brand and reputation; provides a positive example in “integrity-challenged” emerging markets; and helps generate trust for “business” writ large.

So, avoiding devastating risk and achieving affirmative benefits in the company, the marketplace and society, is why the chief executive must lead in fusing high performance with high integrity.

Ben W Heineman Jr was formerly chief legal officer at GE. This is an edited excerpt from his new book, “High Performance with High Integrity”. Reproduced with permission of Harvard Business School Press. Copyright 2008 Ben W Heineman Jr. All rights reserved.

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