Free Management Essays - Explain Principles of Business Ethics with the help of a case study: Enron (a Portion of the Firms Problem)
“No matter which way we turn, it appears that the entire population is whirling within a vortex of mistrust, distrust, misinformation, disinformation, and disclosures. Corporate managements, meanwhile, are scrambling to mend miles of fences between themselves and their boards of directors, banks, investment bankers, stockbrokers, auditors, the media, Senate and House committees, the Justice Department, and the Securities and Exchange Commission (SEC). An array of scandals afflicting corporations and Wall Street over the last few years have created what has been referred to as “a triple-tier Who's Who” for officials under investigation: those who are jail bound, those who might be sentenced and those who have the good luck merely to be greatly embarrassed” (Sims, 2003)
Given the major business implications of violating ethical codes, implications which have been further reinforced by the Sarbannes-Oxley and Basel II legislation, it is important for any management academic or practitioner to understand the principles guiding business and personal ethics, and how these principles can break down. To this end, I propose to investigate several models of ethical behaviour, and use the example of Enron to show how organisation can stray from these models, and how large the penalties resulting from unethical behaviour can be.
Rest (1979) made one of the first major academic contributions to the field of business ethics, proposing the Model of Moral Action that distinguishes four major components intrinsic to the ethical decision-making process: ethical sensitivity, prescriptive reasoning, ethical motivation, and ethical behaviour. According to this theory, a person should first be able to identify the ethical issue, and then judge the issue based on his or her personal ethics, and resolve to comply with this ethical judgment and finally engage in an ethical action. This model describes how various cognitive structures and procedures combine to produce an individual’s ethical behaviour, however different people will judge the same ethical dilemmas differently, and even those with similar ethical sensitivity may feel or understand the dilemma in different ways.
For example, some may think reporting misconduct to supervisors outside the chain of command is an unethical act because it’s disrespectful to the immediate superior. Some, however, believe that such an individual act, as long as benefiting the general welfare of the group, is not in violation of a code of ethics. Moreover, those who believe the reporting is morally wrong hold divergent viewpoints toward the consequences the violator should suffer. Some support heavy punishment due to the seriousness of the act, while the others argue the oral reprimand is sufficient. For that reason, an understanding of an ethical dilemma should exist before the actual decision-making process begins. (Fang, 2006) Equally, any business attempting to encourage people to behave ethically should ensure that it has a clear, consistent and well communicated ethics policy in place within the organisation, and supported by management at all levels, in order to encourage people to follow the ethics of the organisation.
Rest’s (1979) model further states that, once a dilemma has been identified, individuals will start engaging in moral reasoning: evaluating the perceived approach and its outcome in the context of being right and wrong, before making a decision. However, a morally right judgment will not necessarily lead to moral behaviour, as the decision making process involves many other concerns, including an individual’s self interests. For instance, a person understands that giving out company secrets to competitors is morally wrong but may still decide to do it out of self-interest, because he or she fails to establish a moral intent which shows a resolution to act on a moral judgment. (Fang, 2006) In other words, intent is the major determinant of behaviour, and if an organisation does not show enough concern over its ethical policy, this may fall out of employee’s intentions, and thus out of their decision making models. Hunt and Vitell’s (1986) theory on moral judgement argued that moral judgments do not always agree with the intent of action, as one may decide not to act on a decision that is perfectly ethical but on the decision that may bring about an outcome that he or she prefers. This evaluation of outcomes is the major part of the last component of the ethical decision-making process: the performance of moral behaviour, or failure to perform moral behaviour if it does not conform to an employee’s priorities.
One of the key areas where business ethics are frequently called into question, and where there are several theories to explain why people and firms fail to follow ethical guidelines, is in conflict of interest, which has been cited as the reason Arthur Anderson was brought down by the Enron scandal. Perhaps the most notable feature of the psychological processes at work in conflicts of interest is “that they can occur without any conscious intention to indulge in corruption” (Moore et al, 2006). This fact can not only help to explain why citizens accept policies that allow conflicts of interest to persist, but it also has impacts on conflicts of interest in the field of accounting, which has previously been dominated by an economic lens of analysis (Ferraro et al, 2005). Consistent with this economic approach, in models of auditor independence, previous researchers have assumed that independence is mainly a question of whether the auditor chooses to carry out a thorough, unbiased, ethical audit, or to collude with a firm’s managers in hiding poor accounting practices. However, recent psychological research on the impact of motivated reasoning and ‘self serving’ biases leads to questions around the validity of the economic based assumption, claiming that unconscious bias is usually far more pervasive. (Moore et al, 2006) This distinction between conscious corruption and unconscious bias is important, because the two respond to different incentives and operate in different theoretical ways.
Selective perception is one of the key examples of unconscious bias, and Rabin & Schrag’s (1999) theoretical model suggests that people are not very good at “disregarding their own self interests and evaluating information impartially, even when they try to do so.” As a consequence, when choosing how to allocate resources, and make decisions, people honestly believe that they deserve more than an equal share, and that rules which apply to others don’t necessarily apply to them People justify self-serving decisions by using the arguments that happen to favour them (Diekmann, 1997), without awareness of this selectivity. Ignorance of these self-serving biases can have important consequences on the decisions people make, causing people to appear to evaluate evidence in a selective fashion when they have a stake in reaching a particular conclusion.
In other words, they focus on evidence that supports the conclusion they would like to reach, and when they cannot ignore conflicting evidence, they often subject it to additional critical scrutiny. This tendency toward biased information processing prevails even when people on different sides of an issue are exposed to the same information. Whilst some observers have suggested that professional auditors might be less affected by these biases, research has shown that professionals are vulnerable to the same motivated biases as laypeople (Moore et al, 2006). Once auditors learn and encode information from one particular perspective, they are no longer able to objectively assess the data, and they thus view ambiguous data as being consistent with the preferences they have previously shown, which are often the preferences of their clients.
Plausible deniability is another theory explored by Diekmann (1997) and expanded on by Moore et al (2006) They have found that: “When it comes to biased judgments, evidence suggests that people are more willing to endorse a biased proposal made by someone else than to make one on their own.” (Moore et al, 2006) This evidence shows that people tend to be somewhat more cautious about indulging their biased preferences when they are asked to make their own independent proposals, than when they are asked only to approve or reject a proposal made by someone else. The current system, in which auditors are charged only with assessing whether or not the client’s reports comply with GAAP, is thus likely to exploit the tendency to “go along” with the actions of another, even when those actions raise some questions or concerns. (Moore et al, 2006) Another impact of this is that, when one member of staff in an organisation is willing to bend ethics and policy for their own self interests, or in the belief that their actions are in the interest of the firm, it makes it easier for other staff to do the same, thus the ethical violations mount up. This is especially relevant if it is a member of the senior management team who is pushing the ethical boundaries.
Escalation of commitment is another important likely bias, specifically relevant to the realm of conflict of interest, but of relevance to almost all ethical violations. Escalation of commitment was defined by Brockner and Rubin (1985) as the tendency of people to escalate their commitment to a previous course of action for example, in the case of Enron; people ask how Arthur Andersen ever signed off on Enron’s accounting procedures. Brocker and Rubin’s (1985) theory is that, at least in part, moral seduction occurs one step at a time. For example, in one year, Arthur Anderson may have failed to demand that Enron change some of its accounting practices that were at the edge of permissibility. The next year, Arthur Anderson may have felt the need to justify the previous year’s decision and thus turned a blind eye as Enron pushed the boundaries of accounting even further. However, this may have given Enron a subconscious plausible deniability, which aided the company on its descent from a moral paradigm, to bankruptcy and scandal.
Jeffery Skilling, the CEO of Enron, cultivated a strong leadership culture that was designed to push employees and performance as far as possible, encouraging innovation, but also aggression: “Do it right, do it now, and do it better” was his mantra. (Sims, 2003) In the Harvard Business Review’s case study, “Enron’s Transformation”, employees were quoted as saying, “You were expected to perform to a standard that was continually being raised”, “The only thing that mattered was adding value”, and “It was all about an atmosphere of deliberately breaking the rules”. (Bartlett and Glinska, 2001) In such a situation, when staff members are forced to stretch the rules as far as possible in the search for a major success, companies will often foster an unethical organizational culture, due to the lack of ethics being demonstrated by senior management making it easier for employees to claim plausible deniability. (Velasquez, 2006)
Equally, as it becomes easier for more and more employees to act unethically, due to the increasingly selective perception of senior managers, and escalating commitment from the auditors leading to increasingly plausible deniability for many employees, so it became harder for any employee to act truly ethically. Former Enron vice president Sherron Watkins, named as one of Time magazine’s 2002 People of the Year (CNN.com, 2002) failed to stop Enron's collapse, despite sending several memos to Enron’s chairman, Kenneth Lay, warning him about the developing accounting irregularities. Indeed, as a ‘reward’ for bringing these irregularities to the attention of the chairman of the company, with whom the duty of care to shareholders ultimately rested, Watkins was “demoted to a ‘skanky office’ (and) a cutting blow came when she was shown an e-mail from an Enron internal lawyer reminding executives that the law in Texas: where Enron was located, did not protect whistleblowers.” (CNN.com, 2002)
Indeed, according to a poll by CNN and Time magazine, this is the most likely response to bringing unethical behaviour to the attention of senior managers, thus supporting Rest’s (1979) belief that people may not act to prevent unethical behaviour as the fear for the consequences. More than half of people surveyed: 57 percent, believed that whistleblowers would be more likely to suffer negative consequences rather than positive ones. However, this is not the only striking result of the poll, as 73 percent of respondents claimed that they would blow the whistle on serious criminal wrongdoing in their own workplaces. (CNN.com, 2002) However, this result must be viewed in the context of the impact of the three subconscious sources of ethical bias, thus although people may claim they would blow the whistle in a hypothetical scenario, when it comes to the real thing, they may find it difficult to identify both unethical behaviour, and the ethical response to prevent or rectify such behaviour.
In conclusion, the impact of the combination of a ruthless culture, which put value above ethics, combined with the three subconscious theories of ethical violation, led to Enron being forced to declared, in 2001, that its prior financial reporting was inaccurate and that it had overstated earnings by $586 million over the past four years. The obvious consequence of this was that Dynegy’s proposed buyout of Enron, originally valued at $9 billion, collapsed leaving the company with an unsustainable amount of debt: $10.5 billion as of its final annual report, with that number estimated to have grown by 20% by the time of the collapse. (Ackman, 2001) Thus, not only can there be serious internal cultural problems as a result of a lack of business ethics, but also disastrous consequences for any firm, and its shareholders, if such behaviour is allowed to continue unchecked. Preventing such occurrences has now become one of the cornerstones of business ethics, and this is the purpose of the new regulations such as Sarbannes-Oxley and Basel II. Thus, whilst it cannot necessarily be said that it pays for a firm to be completely ethical, and the boundaries will always be pushed in the drive to add value, the potential penalties for a lack of ethics, and the more rigid definitions of what is and is not acceptable, mean that companies will see clear benefits from clearly defined ethics policies, designed to counteract both the conscious and subconscious reasons for unethical behaviour.
References:
1. Ackman, D. (2001) Enron in Free Fall. Forbes.com. Accessed 1st March 2006. http://www.forbes.com/2001/11/27/1127topnews.html
2. Bartlett, C. A. and Glinska, M. (2001) Enron's Transformation: From Gas Pipeline to New Economy Powerhouse. Harvard Business School Press.
3. CNN.com (23rd December 2002) Time names whistleblowers as Persons of Year. Accessed 1st March 2006. http://archives.cnn.com/2002/US/12/23/time.persons.of.year/index.html
4. Diekmann, K. A. (1997) “Implicit justifications” and selfserving group allocations. Journal of Organizational Behavior, Vol. 18, Issue 3, p. 16.
5. Fang, M-L. (2006) Evaluating Ethical Decision-Making of Individual Employees in Organizations - An Integration Framework. Journal of American Academy of Business, Cambridge; Vol. 8, Issue 2, p. 105.
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7. Hunt, S. D. and S. Vitell (1986) A general theory of marketing ethics. Journal of Macromarketing, Vol 6, Issue 1, p. 5.
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9. Rabin, M. and Schrag, J. L. (1999) First impressions matter: A model of confirmatory bias. Quarterly Journal of Economics, Vol. 114, Issue 37, p. 82.
10. Rest, J. R. (1979) Development in Judging Moral Issues. University of Minnesota Press.
11. Sims, R. R. (2003) Ethics and Corporate Social Responsibility: Why Giants Fall. Greenwood Press.
12. Velasquez, M. (2006) Business Ethics: Concepts and Cases, 6th Edition. Prentice Hall.
