Rule 1: The Importance of Business Ethics

In a world disillusioned with globalisation, the importance of business ethics is greater than ever. Business needs to be truly acting in a way which goes beyond purely profit-based motivations, towards a model which works for everyone - what we call the Triple Bottom Line: People, Planet, Profit. We believe in this so passionately we have it as our slogan. It is also why we will give 10% of sales of our corporate governance course to charities supporting entrepreneurship, thus helping the poorest to lift themselves out of poverty.

An ethical approach is fundamental to sound business practice... it underpins the structures and systems used to ensure good governance and without it governance will fail.

So the first of our Golden Rules of Corporate Governance is that the business morality or ethic must permeate an organisation from top to bottom and embrace all stakeholders.

Factors highlighting the importance of business ethics

In the second decade of the third millennium, we can cite four major factors which highlight the importance of business ethics (we define business ethics here):

  1. Long-term growth: sustainability comes from an ethical long-term vision which takes into account all stakeholders. Smaller but sustainable profits long-term must be better than higher but riskier short-lived profits.
  2. Cost and risk reduction: companies which recognise the importance of business ethics will need to spend less protecting themselves from internal and external behavioural risks, especially when supported by sound governance systems and independent research
  3. Anti-capitalist sentiment: the financial crisis marked another blow for the credibility of capitalism, with resentment towards bank bailouts at the cost of fundamental rights such as education and healthcare.
  4. Limited resources: the planet has finite resources but a growing population; without ethics, those resources are repleted for purely individual gain at huge cost both to current and future generations.

1. Long-term growth

Large profits are always attractive, potentially allowing faster achievement of strategic goals, a greater provision against risk and a greater sense of success and stability. However, there are countless examples in corporate history of dramatic boom and bust cycles (both on a micro, corporation level and macro-economic level). Now, more than ever, we need to re-evaluate our endless search for bigger and bigger profits with the bigger and bigger risks that entails. The financial crisis which began in 2008 is painful evidence of that. Whole countries have gone to the brink of bankruptcy as a result of an unwillingness or inability to plan long-term.

More and more organisations are recognising what most owner-run businesses have always known: that stable profits are a better bet in the long run than large profits now and an uncertain future. It is on the long term which we must focus to avoid the blindness which leads to such huge corporate collapses as Lehman Brothers (2008) and such huge risks and balance sheet holes as Morgan Stanley (as late as 2012). Even the largest remaining investment banks like Goldman Sachs are having to recognise this (if only to try and fend off more aggressive regulation) and attempting to make their bonus allocations more dependant on longer term value than the current year’s performance. One can only hope that the heads of such organisations recognise the importance of business ethics and the resulting need to change to a more sustainable model of growth.

Certainly the only way to change the huge, unwieldy vessel that is global business is to focus on the business benefits. While it may seem contradictory and hypocritical to place self-interest at the heart of change for the better, it is the only conclusion that seems to offer hope. Fundamentally the importance of business ethics is driven by personal ethics and morality and most people are fundamentally self-interested. But, if it is in people’s best interest to be ethical, this has the potential to drive real change. It is already happening in several consumer markets where demand is shifting to ethical products and social networks are instrumental in spreading stories about unethical practices. (Sadly, very rarely is positive action rewarded with the same degree of enthusiasm but with some good - but earnest - marketing, it can be given a kick start and be highly successful long term.)

2. Cost and risk reduction

A precedent which argues the case made above is the Quality Management industry. In the West, this sprung up in the early 1980s, when products began to be inspected before leaving the factory in an attempt to reduce the amount of costly customer complaints. Now, most products come with at least a one-year warranty and in the case of some car manufacturers, up to five years. What started off as a self-interested need to reduce costs has led to more reliable products.

Note: The idea of "built-in obsolescence" is a separate issue in which consumer demand for more and more new products is arguably the bigger culprit (this is likely to be the subject of a future blog post!)

Meanwhile, we offer another analogy from wider society. Just as widespread bribery and corruption in society are recognised as being inimical to the development of a healthy economy, similarly the lack of a high standard of ethical behaviour in a company is inimical to trust and loyalty, which in turn has a detrimental effect on the health of the company over the longer term.

It may be argued that an owner can run a business in whichever way he or she wishes, and at first glance there would appear to be a case for this so long as no other shareholders are involved, and only his or her money is at risk, and of course with the acquiescence of the employees and trading partners. However, in many years of observing different standards of behaviour in different business circumstances, one recognises the relationship between the perception of ethics which permeates an organisation and the degree of trust and loyalty present among employees and between staff and management. The conclusion one reaches is that loyalty and trust have a significant value in terms of the efficiency and effectiveness with which a business can be run, and the concomitant cost of control systems needed.

In other words, a highly ethical operation is likely to spend much less on protecting itself against fraud and will probably have to spend much less on industrial relations to maintain morale and common purpose. This should be motivation in itself to recognise the importance of business ethics and instil good corporate governance in any organisation.

Importance of Business Ethics: Pressures on Long-Term Growth

3. Anti-capitalist sentiment

The eye-watering profits of some of the world’s largest corporations attracts a lot of negative sentiment from those outside the world of business and finance. While clearly a result of the scale of these organisations, there is always a suspicion that these profits have been achieved through not entirely ethical means - and in some cases downright unethical means, often resulting in major public failures, most recently in Japan, where the senior management of Nomura resigned en masse after an insider trading scandal.

Banks in particular receive a lot of bad publicity over profits and executive pay (especially bonuses), and while not always justified, the fact is, an industry at the centre of the credit crunch and resulting economic and financial crisis continued to produce hefty profits and bonuses even while making large numbers redundant. This is, of course, a huge generalisation and simplification of the issue (this is not place for such details) but it is the natural reaction of the general public, who lack such detailed information and understanding. Public sentiment cannot be ignored. This situation makes the importance of business ethics all the more pressing in the 21st century.

4. Limited resources

One irrefutable fact is that this planet has limited resources. Probably the biggest failure in human development over the last three hundred years has been in recognising that and attempting to minimise use and maximise re-use and recycling. While there are now global initiatives to try and reverse this trend, and much progress has been made, there is still a long way to go. In the major developing economies, especially, history is repeating itself on a massive scale. With notable exceptions, this applies not only to specific environmental and sustainability issues but to corporate governance generally and the importance of business ethics to the new high growth regions and corporations.

This is another example of short-termism prevailing over long-term vision and preservation of limited resources for future generations - and in some cases the same generation, as in deforestation driving native peoples and animal species to the point of extinction. Just as basic financial management requires planning to ensure capital reserves and so solvency, the same principles should clearly apply to the extraction and usage of natural resources.

There are some notable exceptions, of course, with the likes of Sir Richard Branson (founder of the Virgin empire) taking a keen interest in environmental affairs (as well as entrepreneurship). On a governmental level, the 2012 London Olympics are the "greenest" ever, with 40% reduction in water usage (despite the record amount of parks and planting) and 98% waste recycling. Let’s see how Brazil picks up the baton in the quest for a carbon neutral Olympics. And how the private sector accepts the importance of business ethics in the rapid development they are experiencing.

Conclusion: evaluating business ethics and implementing improvement programmes

An experienced eye and ear will recognise the ethical stance of a business within a fairly short while from talking to directors and senior management, and this will be rounded out by discussions with a representative sample of staff, particularly those concerned with customers and personnel management. It will almost certainly be confirmed by a conversation with the Finance director and an appreciation of how the money matters are dealt with.

Clearly it is necessary to deploy rather more than gut feel in examining a business’s position in regard to business ethics and in the rest of this corporate governance best practice section and our corporate governance course you can find out how to install an effective, ongoing assessment and monitoring programme which uses primary research, including market research, a key differentiator to other approaches. In our view it is the only way to pick up on questionable behaviour and so ensure good corporate governance. It is also offers a highly effective and detailed way of measuring the importance of business ethics to all within - and connected to - the organisation.

This is the first in our series on Best Corporate Governance Practice - the Golden Rules of corporate governance:

Rule 1: The Importance of Business Ethics
Rule 2: Towards a Common Goal - Align Business Goals
Rule 3: The Importance of Strategic Management
Rule 4: Organisational Effectiveness for Good Corporate Governance
Rule 5: The Importance of Corporate Communication

Return from Golden Rule No.1: The Importance of Business Ethics to Best Corporate Governance Practice: the Five Golden Rules

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