Are Corporate Ethics Dead?

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It isn’t a new revelation that ethics seem to be dying in corporate America. But it’s a little surprising how far unethical behavior has spread. After the revelations of David Sokol’s actions at Berkshire Hathaway (NYSE: BRK-B  ) , it appears not even the seemingly untouchable Warren Buffett is immune from the long reach of questionable behavior.

But this isn’t something new in the boardroom. Ethics have played a role in shaping corporate America and the laws governing it for well over 100 years. And while today’s ethical conundrums may create more headlines, they’re not any more egregious than their predecessors.

The biggest name in business
John D. Rockefeller, one of America’s most famous businessmen and philanthropists, was also instrumental in leading the U.S. to create harsh antitrust laws because of his business practices. Railroad rebates, price discrimination, industrial espionage, bribery and unfair competition are among the things Rockefeller is remembered for. And some credit his Standard Oil for spurring the passage of the Sherman Antitrust Act in 1890, which led to the eventual breakup of the company.

More familiar names, including Microsoft (Nasdaq: MSFT  ) , AT&T (NYSE: T  ) , and IBM (NYSE: IBM  ) would eventually come under the same scrutiny late in the 20th century. But were these companies just doing good business, or were they acting unethically? For instance, was it ethical for Microsoft to bundle Internet Explorer with Windows to squeeze out Netscape? The line is a little blurry sometimes.

Likewise, if Sokol had disclosed his position but traded on the information first, that might have addressed concerns of insider trading, but still -- would it be ethical? On a more personal level, if I write an article about a stock I already own, saying why I think that stock is a great buy, is there an ethical problem about that -- even when I tell readers it's already in my portfolio? It’s an issue that can be viewed through many lenses.

It starts in the classroom
Ethics classes are now a staple at most major MBA programs, where many of the corporate elite are educated. But in my experience (as an MBA graduate), they're viewed as an exercise in justifying whether something is ethical or not, instead of a way to create an ethical corporate culture.

The joke during ethics class was that we were actually learning how to justify anything we may do. So don’t think that a highly educated executive like Goldman Sachs (NYSE: GS  ) CEO Lloyd Blankfein lost any sleep over the money Goldman got from AIG when taxpayers bailed out the insurer's credit-default swap derivative positions. And he definitely didn’t feel bad being short the mortgage market while his company pumped out mortgage-backed securities as fast as it could. He has justified these actions in whatever way he deemed necessary. Maybe he was looking out for shareholders or employees. Somehow there’s a justification.

It’s as easy as pie
The other problem is how easy it is for executives to behave unethically and escape punishment from shareholders. Voting in shareholder ballots can feel like an exercise in futility unless you have a big-name investor leading the charge. And much of the time, board members aren’t really independent parties; they’re often hand-chosen by the CEO.

Take, for example, DryShips (Nasdaq: DRYS  ) CEO George Economou, who has done his share of dubious dealings. But the board hasn't put a stop to Economou's questionable behavior.

Then there’s the sticky situation that investors in China MediaExpress (Nasdaq: CCME  ) find themselves in. After Citron Research blasted the company in a report calling it “too good to be true,” the stock dropped, causing management to respond with a letter which included the assertion that “revenues and cash position have been audited by reputable and well-known auditors who have confirmed both.” Last month, that reputable firm, Deloitte Touche Tohmatsu, resigned, saying it was “no longer able to rely on the representations of management.” Since then, trading in the stock has been suspended, and the company has received notice that its shares are subject to being de-listed from the Nasdaq exchange, and sued by Hank Greenberg’s Starr International, one of its largest shareholders.

Who, exactly, is at fault in these cases? The board, CEO, investment bankers, the SEC -- the buck never stops definitively with anyone.

Heads I win, tails you lose
Maybe the biggest problem in corporate America today is that it isn’t the management team’s money. Take almost any large cap stock, and you’ll see that CEOs typically hold a very small percentage of the company’s stock. Often, CEOs get substantial compensation in stock options (although this is changing). Stock options will be worthless if the stock trades below the strike price, but may be worth a fortune if the stock trades above the strike price.

If that sounds a little like a game called roulette, you’ve already identified one of the biggest problems in corporate America. If the CEO makes a bad call, shareholders lose their money, but CEOs still enjoy hefty paychecks. But if the ball falls on the CEO's number, an island in the Caribbean and a life of luxury waits.

Ethics is as dead as it ever was
As I see it, unethical behavior hasn't gotten worse over the last 10 or 20 years. It’s just that we’re able to find corporate schmucks much more easily than back in the Rockefeller days. Fake stock certificates even used to be traded on Wall Street, a fraud much easier than Bernie Madoff could have devised.

As ordinary investors, we may feel helpless to improve ethics on Wall Street. But we need to keep an eye out for ethical management that will keep an eye on our money. It’s not an easy task, but looking for a CEO with skin in the game and a credible history is a great place to start. Yet as Buffett's experience reminds us, even a CEO with an incredible history gets burned every once in a while.

Editor's note: A previous version of this story incorrectly stated that China MediaExpress had already been de-listed from the Nasdaq. The Fool regrets the error.

Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw. Berkshire Hathaway and Microsoft are Motley Fool Inside Value picks. Berkshire Hathaway is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Berkshire Hathaway, IBM, and Microsoft. Alpha Newsletter Account, LLC owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 15, 2011, at 7:33 PM, TMFFlushDraw wrote:

    This should read that CCME has been suspended, not delisted. A fix is in the works.

    Travis Hoium

  • Report this Comment On April 16, 2011, at 11:52 AM, camour wrote:

    I have no doubt that all these people who engage in dubious behavior, at the end, they are called upon to pay a price. I anticipate that one of these days George Economou of DRYS would be called upon to account. It would not be because of any specific infringment of the SEC rules but rather of the general law of fiduciaries and breach of loyalty in double dealings, advancing his personal interest at the expense of the beneficiaries, the shareholders.

  • Report this Comment On April 17, 2011, at 11:02 PM, noevidence55 wrote:

    Well Travis, I see you are like SA writers and many others. Just write what the he** you want with inaccuarte information, and then state a "fix" is in the works?? Where is the fix??? back in the day, writers, and editors were responsible for what they wrote, AND had some ethics....CCME is not de-listed. How you came upon that info and actually wrote it here shows your incompetence as a ethical, responsible writer.

  • Report this Comment On April 17, 2011, at 11:03 PM, noevidence55 wrote:

    By the way, its HALTED, not suspended...a difference you know, or do you?

  • Report this Comment On April 18, 2011, at 9:51 AM, ethicsblogger wrote:

    Two quick points:

    1) It's worth pointing out that the last 2 paragraphs put the lie to the first sentence. Unless, that is, we put a lot of weight on the word "seem", which is maybe what Travis intended. Because I guess it does "seem" to a lot of people like ethics is dying, though that is clearly false (as the rest of the article rightly suggests).

    2) It's also worth noting the various 'levels' at which we might look for ethics. If we're thinking about individual decisions, then it's absolutely right that not much has changed: people are still people, subject to the same temptations as they always were. But if we look at institutions and organizations, a lot has changed. Business today is more ethical than it has ever been before: more transparent, less racist, less sexist, more environmentally-conscious, etc etc.

    Chris MacDonald

  • Report this Comment On January 04, 2012, at 8:34 PM, WEBbuff wrote:

    The question of corporate ethics is difficult, if not impossible, to decisively resolve, and indeed is often ridiculed (as Travis' reference to the MBA students' joke about ethics courses reveal). Corporate executives seem incentivized to sacrifice ethics for financial expediency, or at least encouraged to mask unpalatable behavior behind an ethical cover.

    I think a more relevant question is to what extent ethical behavior on the part of executives (and all businesspeople, for that matter) informs our investment decisions. Are we comfortable investing in a company run by a person with a known history of questionable activities (as in the DryShips example Travis reminds us of)? Embracing the world of hypotheticals, would we rather invest in a company trading at half of its book value but run by a hopelessly corrupt executive, or invest in a company trading at or slightly above book value but run by a verifiably ethical CEO (assuming both companies have equal revenue streams, profit margins, etc.)?

    I think the best way to answer these questions, which Travis suggests at the end of the article, is to determine whether the CEO owns a significant portion of the company. David Gardner wrote an excellent article several years ago about the important of "insider ownership."

    One final note: we might consider judging a particular executive's ethical conduct by comparing it with that of similarly situated executives. John D. Rockefeller certainly circumvented and, perhaps, broke laws, but so did other prominent, contemporary investors like Jay Gould. This may mean that corporate ethics will never fully motivate all executives to "do the right thing," but it will provide a more reliable basis for assessing the comparative morality of an action in the world of business.

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