Preventing Corporate Scandals

Early in my career, I asked a mentor how to tell the difference between right and wrong in the business world. He said, "Before acting, ask yourself, 'Do I want to see this on the front page of The Wall Street Journal?'" It was great advice, but someone must have forgotten to teach it to other corporate leaders. Opening fake bank accounts, rampant sexual harassment in news organizations, cheating on emissions testing, and expensive essential medical devices are just some of the recent scandals. We should learn from these events to prevent corporate scandals from happening in our businesses.

As a leader, here are a few things you can drive in your organization:

Teach by Example

When growing up, our parents and teachers didn't give us written home policies and procedures or check on us with a Kid Audit Department. So how did we learn right from wrong? We did it by watching and mimicking people around us in positions of authority. In other words, our parents, teachers, and older siblings were teaching by example.

The same is true in an organization. People in positions of power are mimicked by others in the organization. Therefore, the first and most important step in preventing corporate scandals is to ensure that your company's leadership models proper behavior to the organization.

For the top managers of small companies where employee interaction happens on a daily basis, this means doing the right thing every day—simple but not easy. Many companies are large enough that direct interaction between top management and most employees do not happen daily. For those companies, other controls must be established.

The first thing the company must have in place is an ethics policy statement. This document is known by many names (e.g. "Our Values"), but it essentially outlines management's expectations of how the company will conduct business and the values the company esteems. To remain credible, company management must ensure nothing the company does or espouses through policies and procedures contradicts these values.

In addition, the company must have an independent and secure system that allows the anonymous reporting of potential infractions and unethical behavior by any employee. The best whistleblower systems are managed outside the company and reviewed at the highest level (including by the board of directors).

Most companies hold required annual training for their employees on topics such as conflicts of interests, cybersecurity, and more. It's a good practice to include a review of the company's values and how to use the whistleblower system in this training, too.

Be very careful with your company's compensation schemes. When establishing a performance indicator for bonus payments, ask, "What unintended behavior could this metric cause?" The very noble drive for increased sales at Wells Fargo and Volkswagen led to employees opening fake accounts for customers and inventing a way to cheat emissions tests. Also, your employees will know if you're rewarding those who push the boundaries to get results over those who don't. Make sure your employee evaluation programs measure the right behavior in addition to the right results.

Follow the Profit Chain

Now that you've set the right tone, it's time to run your business. The goal of any for-profit business is long term profitability. In the book, "The Service Profit Chain," authors James Heskett, W. Earl Sasser, and Leonard Schlesinger outline the way companies turn a profit. Nowhere in that book is cheating encouraged as a way to increase profitability.

Instead, a sustainable profit is achieved only through loyal customers. To keep your customers happy, you need to manage a series of properties of your operations that, when performed together, lead to customer loyalty. The three authors call this the "service profit chain" (below).

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The authors' research shows that a company must invest in the Employee chain and Customer Value chain to reach Profitability. Furthermore, each step in the chain drives the next chain (the Employee chain drives Customer Value, etc.)

To avoid corporate scandals, investment decisions must determine whether an investment is driving a step in the chain. For example, software to cheat emission testing doesn't enhance any of the steps, and increasing the cost of medicine 600% actually reduces Customer Value.

Instead, investments that enhance the chain include:

1. Employee chain: Invest in strong quality programs, customer facing systems and organizations, and systems and tools that make employees' job easier. An unsatisfied employee is three times more likely to leave a company than a satisfied employee. They're also more likely to sabotage the company or create a situation that may lead to a corporate scandal. Some studies show that the cost to hire and train a new employee is six to nine months of salary, but the real cost of losing an employee is the loss productivity. In a recent study I read, it cost five years and $2.5 million for brokers at a securities firm to rebuild relationships that were established by their predecessors.
2. Customer Value: Perceived value by the customer increases with the results the customer sees and decreases with the cost of these results to the customer. Therefore, invest in products and services that the customer wants, and in ensure these products are of high quality. Also invest in ways to reduce the cost of these products.

If a company invests in these things, the results will be an improvement in the Customer chain. Studies show that customers who describe themselves as "very satisfied" will remain a customer 80% or more of the time. They're likely to tell up to five other potential customers about you. On the flip side, customers that describe themselves as "slightly dissatisfied" or worse only remain a customer less than 40% of the time. They're likely to tell 11 other potential customers to stay away.

Not only is following the service profit chain good business, but it will keep you out of trouble.

Remain Vigilant

In science, the second law of thermodynamics states that any system, left alone, will become more disorganized over time. This is true of a corporation as well, so you must remain vigilant.

To prevent corporate scandals, diligently review the data collected in your organization and look for trends that don't make sense. Are you seeing an increase in new products sold without a corresponding increase in revenue? Did your team solve a long-standing challenge without introducing a new technology or system? Are you experiencing an increase in HR complaints or calls to your whistleblower hotline? All of these could indicate trouble is brewing.

You should cultivate a culture of continuous improvement. Are you mining the root causes of incidents that didn't go as planned? How are those learnings incorporated into the way you do business?

Victor Hugo said, "Initiative is doing the right thing without being told." Thankfully, you can help the initiative of your organization to prevent corporate scandals by setting the right tone from the top, investing only where it drives customer loyalty, and remaining vigilant for signs of trouble.

Trenegy helps companies design and implement controls frameworks to ensure policy and procedures are in place to prevent slips and scandals. For additional information, contact us at info@trenegy.com.