6 Baltzer Science Publishers Turn Culture Into Competitive Advantage Lessons from recent risk management failures Leslie Altizer* This article discusses CEB s research, lessons learned, and what organizations can do to prevent misconduct and compliance issues, and improve culture. It is now well understood, in boardrooms and beyond, that ethics and compliance lapses can be very costly. During the past two years, there have been several multi-million dollar penalties related to the U.S. Foreign Corrupt Practices Act alone. Quite a few of these penalties have been the result of lapses within the Life Sciences and Pharmaceutical industry. When you add in the costs of harassment, discrimination, conflicts of interest, fraud, records mismanagement, and accounting irregularities, these numbers routinely run into the billions. Even these numbers pale in comparison to lack of confidence from investors, the public, and a company s own management and employees. The cost of these ethics and compliance breakdowns is certainly not new and additional factors have elevated the consequences and likelihood of compliance risk: Ri s i n g r e g u lato ry c o m p lex ity c ou p le d with g r eate r r e g u lato ry e n f o rc e m e nt an d f i n i n g auth o r ity. For example, companies face large penalties related to the UK Bribery Act, the Dodd-Frank financial regulation, and an assortment of industry-specific regulations. pr e s s u r e f o r n ew r eve n u e i n s low g rowth e c o n o m i e s an d u n fam i liar mar k ets. Often these markets have substantially different commercial and cultural norms, creating very real risks as firms try to reconcile fast growth and rapid local hiring with heightened regulatory expectations. As a result of this increased scrutiny * Leslie Altizer is Director of the CEB Compliance and Ethics Leadership Council.
7 2012 Median Compliance and Ethics Budget 2012 Median Compliance and Ethics Full-time Staff Average Number of Hours of Compliance and Ethics Training Required of ALL Employees Global Average $1,500,000 10 3.4 Pharmaceuticals and Biotechnology $3,500,000 16 7.88 Banking and Financial Services $5,000,000 96 7.97 Insurance $11,700,000 102 4.00 Figure 1: Key Compliance and Ethics Program Benchmarks of Highly Regulated Industries and attention from regulators, companies particularly in heavily regulated industries have heavily invested in bolstering the compliance infrastructure with steps such as large compliance budgets and teams, frequent policy updates, and additional training curriculum. (See figure 1 1 ). However, these steps only address a small part of the potential problem at best. While such foundational program elements represent critical building blocks, they often fail to actually change employee behavior. Often, organizational culture or the unwritten rules not process breakdowns, serve as the root cause of compliance failures. The most successful companies make the long-term investment to build a strong culture of integrity and these companies enjoy benefits such as reduced compliance violations, improved risk detection, higher employee productivity, and stronger financial performance. 1 Source: CEB 2012 State of the Compliance and Ethics Function Benchmarking Survey of 267 companies. Survey data was collected from CEB RiskClarity, a ethical cultural survey measuring employee perceptions of integrity at their companies. Data was collected from 24 global companies across 2012. Improving Your Culture of Integrity Reduces Misconduct and Increases Risk Detection If you polled 10,000 compliance and ethics officers and asked them what outcomes they care the most about for their programs, the majority of responses are likely to center on reduced number of compliance violations and increased ability to detect violations when they occur. These two critical outcomes are what most compliance and ethics activities are targeting and attempting to influence. And while investments in bolstering the ethics and compliance infrastructure and systems are important, culture is ultimately your greatest ally. To illustrate, despite significant dollars spent on hotlines and other reporting mechanisms, only about 5 percent of employee reports ever make it into the hotline. In fact, roughly half of observed misconduct never gets reported by employees and 60 percent of reported misconduct does not escalate beyond direct managers 2. However, companies 2 Source: 2012 CEB RiskClarity benchmark database of 293,326 global employees across 25 companies.
8 Responses on the CEB RiskClarity Integrity Index* Employees, on average, responded Somewhat Disagree, Disagree, or Strongly Disagree Employees, on average, responded Neither Agree nor Disagree Employees, on average, responded Somewhat Agree Employees, on average, responded Agree or Strongly Agree Unfavorable 5.9% Neutral 9.4% Favorable 20.9% Most Favorable 63.7% Observation Rate** 61.5 32.9 17.0 7.2 Reporting Rate*** 53.0 51.3 56.7 74.2 *The Integrity Index is an 18-question index score a company receives as part of the CEB RiskClarity survey. The questions are on a 7-point Strongly Agree to Strongly Disagree scale; **Percent of employees within category who observed misconduct in past year; ***Percent of employees within category who reported the misconduct they observed Figure 2: Impact of Cultures of Integrity on Key Compliance and Ethics Program Outcomes with strong cultures of integrity 3 face far fewer percentages of employees observing misconduct and a much larger percentage of employees reporting observations or concerns than those companies with weaker cultures of integrity (see figure 2 4 ). A Strong Culture of Integrity Can Net Greater Employee Productivity and Financial Gains In addition to the dollars saved through decreased compliance violations and proactive risk identification, companies can also drive increased employee performance and stronger financial gains through investments in integrity capital. CEB analyzed financial, operational, and cultural data from 34 publicly traded 3 A strong culture of integrity is measured and defined using the CEB RiskClarity Integrity Index. The Integrity Index is a series of questions measuring the strength of employee perceptions as related to key behaviors associated with high integrity (e.g., employee comfort speaking-up and tone-at-the-top). 4 Source: 2012 CEB RiskClarity benchmark database of 293,326 global employees across 25 companies. companies to better understand the linkages between culture and business performance. First, regression analysis showed that top quartile companies outperformed bottom quartile 5 companies in 10-year Total Shareholder Returns. As Figure 3 shows, those companies that have made culture a strategic priority have seen up to 16 percentage point higher total shareholder return than those companies that have been less successful in building cultures of integrity. (See figure 3 on the next page 6 ). Secondly, additional analysis found a strong connection between managers demonstrating corporate values and ethical behavior and overall employee performance, measured as discretionary 5 CEB divided the 34 companies into top and bottom quartile groups based upon their scores on the Integrity Index. Top quartile companies scored at or above the 75 th percentile and bottom quartile companies scores at or below the 25 th percentile. 6 Source: 2010 CEB Compliance and Ethics Leadership Council s Ethical Leadership Research
9 Average 10-Year Total Shareholder Return for Bottom and Top Quartile Companies Bottom Quartile of Integrity Index -7.4% 8.8% Top Quartile of Integrity Index Correlation (r) = 0.58 ; n=34 ; Significance level of Correlation: P-value < 0.01 Figure 3: Higher Integrity, Stronger Long-Term Total Shareholder Returns effort 7. In fact, when managers act as strong ambassadors for compliance and ethics conduct, employee discretionary effort increases by as much as 12 percent. As explained in the next section, ethical leaders at all levels of management play critical roles in driving culture throughout the organization. While it is likely that business performance and corporate culture both, to some degree, drive the other, it seems clear that cultures where employees freely speak-up to honest, respectful senior leaders increase financial gains, improve employee productivity, and better avoid risk management pitfalls. Defining a Culture of Integrity The benefits are clear so how do you put all the pieces together? Defining and understanding a culture of integrity is not always easy and building and fostering one can feel even more intimidating. Companies routinely face challenges and 7 Discretionary effort is the respondent s willingness to expend effort beyond typical expectations. Examples of this behavior include willingness to invest additional time and effort to accomplish a task or looking for ways to perform one s job more effectively. push back when implementing strategies to effectively drive desired employee behaviors. Compliance and ethics officers often find themselves asking questions such as: H ow d o I d e f i n e a c u lt u r e o f i n t e g r i t y w i t h i n m y ow n c o m pany? A culture of integrity addresses behaviors that drive employees to commit violations or not report concerns upwards, causes may differ from company to company. h ow ca n I c r e at e s t r o n g e r eth i cal lead e r s an d b uy-i n? Leaders at all levels of a company may not appreciate the importance of culture, be insufficiently accountable for compliance and ethics, and/or not understand how to be strong ethical leaders. How do I m easure culture an d th e n c r eate e f f e ctive acti o n p lan s? Measuring abstract behaviors and perceptions are not always easy to translate into tangible action steps that are linked to positive outcomes.
10 Through our employee-based culture survey, CEB RiskClarity, we surveyed more than 1,000,000 global employees to help companies define, measure, and build strong cultures of integrity. Companies with strong cultures of integrity as measured through CEB RiskClarity s Integrity Index all share common characteristics. 1 E t h i c a l L e a d e r s h i p a c r o s s all leve ls o f manag e m e nt. CEB defines Ethical Leadership as those managerial attributes which inspire employees to deliver high performance results against business objectives while embodying the values of the organization. Key characteristics of ethical leaders are honesty, accountability for actions of self and others, respect, trust, and listening. 2 Awar e n e s s o f h ow to r e p o rt c o n c e r n s o r vi o lati o n s. CEB has found that leading companies develop policies and procedures that formalize corporate efforts to encourage employees speaking up. These efforts include escalation policies, decisionmaking criteria, and training curriculum all of which is clearly articulated and available to employees. 3 Em ployees who are not fearful o f r etaliati o n i f th ey r e p o rt a c o n c e r n o r vi o lati o n. The primary reason employees fail to report observed misconduct is fear of retaliation. The best companies directly address employees fear of retaliation by creating cultures of risk awareness and comfort speaking up. 4 E m p l o y e e s w h o h av e f a i t h i n t h e r e p o r t i n g a n d di sci p li nary p roce ss du b b e d o rgan i zati o nal j u sti c e. When employees feel that their companies do not deal with reports of misconduct appropriately, perceptions of ethical culture decline dramatically. The best companies act decisively on instances of misconduct and publicly demonstrate corporate commitment to upholding compliance and ethics expectations. Let s take a moment and explore how companies have successfully used these building blocks to form, foster, and sustain their own cultures of integrity.
11 Focus on four vital leader qualities and rigorously measure management integrity. Leaders behavior shapes subordinates behavior. Although this may seem cliché or obvious, it is a true and vital fact supported by our analyses. A company that effectively implements dozens of processes and systems designed to enable information flow but does not have leaders with the right qualities will fail. Although 20 qualities often associated with strong leaders are laudable, only the following four are statistically proven to both foster a healthy culture and reduce the likelihood of misconduct: Organizational justice Honesty and integrity Respecting and trusting employees Listening carefully to the opinions of others All companies expect their managers to have integrity; however, companies with strong cultures of integrity go much further by rigorously measuring the integrity of their management teams. They use both objective and subjective measures and give each manager a score that ties to their promotion and variable compensation. As managers rise in the organization, they are expected to achieve increasingly high, clearly defined levels of integrity. Managers are provided and subject to training, communication, and enforcement mechanisms customized to their level. For example, companies may require their senior-most executives to repay bonuses granted for up to five of the preceding years if an appropriate action could have prevented a direct report s violation of an applicable law that resulted in financial loss. Leading companies objective measures include: Staff training and certification completion rates, Cultural survey scores (percentage rank relative to peers), Frequency of formal staff communications that reinforce corporate values, and
12 Completion of compliance goals as set forth in risk mitigation plans. Leading companies subjective measures include: 360-degree values assessment, Feedback from exit interviews and focus groups, and Business unit compliance selfassessment results. Establish company-wide speaking-up protocols and train your workforce. In order for employees to escalate concerns appropriately, companies must set a clear, easy-to-find speaking-up policy as part of the code of conduct or as a standalone policy. The policy will clearly identify what constitutes a violation or concern, provide at least one phone number for reporting, and should provide a means to report anonymously. Some companies will even build a webform that employees can use to actually submit a report. Sixty-nine percent of companies require their entire workforce to complete training on recognizing and reporting misconduct at least every three years 8. Leading companies will also develop creative and innovative roll-out strategies to raise awareness around how to report concerns. These companies will utilize posters, manager-led training, tear sheets, intranet sites, and/or newsletters to provide engaging communications to their workforce. Alleviate fear of retaliation by creating open and honest work environments. Regardless of policies and escalation criteria, employees are not likely to elevate risk information if they have a fear of retaliation. Of employees that observed misconduct in the past year but did not report it, nearly one-third of those employees chose not report because they feared retaliation 9. 8 Source: CEB 2012 State of the Compliance and Ethics Function Benchmarking Survey of 267 companies. 9 Source: 2012 CEB RiskClarity benchmark database of 293,326 global employees across 25 companies.
13 Retaliation can take many forms in the workplace including being ostracized by peers, loss of compensation or job, passed over for opportunities, just to name a few. Often, employees will form perceptions that retaliation exists without ever truly experiencing retaliation or by perceiving certain behaviors to be retaliation even if that is not the intention of the other employee(s). To help mitigate the risk of retaliation, real or otherwise, companies should: Develop a clear non-retaliation policy and train all levels of employee; Take disciplinary action against employees who have committed retaliation against reporters; Measure employee perceptions of retaliation in the workplace through employee surveys or focus groups; Train managers to respond appropriately and consistently to employee reports of misconduct; and Provide managers (and ethics liaisons) the tools and resources to handle concerns to prevent perceptions of retaliation. Deliver organizational justice by responding quickly and consistently to unethical practices. A company s culture has organizational justice when employees agree that 1) their company responds quickly and consistently to verified or proven unethical behavior and 2) unethical behavior is not tolerated in their department. Organizational justice as a driver of culture is almost three times more powerful than all other leading drivers combined. To advocate organizational justice, leading companies focus not only on convincing employees, but also on quickly identifying misconduct. In addition, they mitigate future misconduct and reduce potential offenders over time by attracting and retaining the right employees. While most companies effectively respond to illegal or unethical behavior, most employees (even most managers) never know it. Leading companies show employees that when unethical behavior is uncovered, people are held
14 accountable, and the company does the right thing. To foster organizational justice, leaders should: Set clear expectations that unethical behavior is not tolerated; Hold employees at all levels consistently accountable; and Share details regarding detected, punished misconduct (within the bounds of privacy laws). Find your hidden, weak links and target efforts on the least compliant areas. Ultimately, what gets measured gets done. Measurement should be at the beginning, middle, and end of every cultural strategy implemented. Measurement uncovers areas of risk, potentials challenges, and bright spots that would otherwise remain hidden. Even for companies that enjoy strong cultures of integrity, this critical risk remains: the lowest scoring business unit, region, or department is often ignored when executives only see averaged results. The likelihood of an employee speaking up about a compliance issue often varies by 30 percentage points or more between the most and least compliant groups. Leading companies focus attention on the least compliant locations, especially by gathering information directly from employees who work there. Face-to-face interaction with frontline employees provides them a more detailed and accurate picture of local manager and peer behavior than broad surveys can provide. After developing a clear understanding of local challenges, leading companies managers develop and implement remediation plans that include intense coaching and training. Summary Global organizations are facing ever more costly compliance and ethical failures. In response, such organizations have developed and are spending a lot of money on compliance programs, risk management and training for their employees. While such measures can help, Compliance & Ethics Officers experience marginal returns on investment at best, without creating a sustainable, longterm change that actually reduces
15 misconduct or increases the chance of earlier identification. By contrast, those organizations that consistently focus on defining, measuring and fostering a culture of integrity stand a much higher chance of long-term success. At a minimum, Compliance & Ethics Officers together with other functional partners like HR should create an open environment of communication, where employees feel comfortable speaking up about the good, the bad and the ugly news they hear. Essential to comfort speaking up is establishing zero toleration for retaliation, as well as assuring employees that when employees report misconduct, swift and just action of the company will follow and employees at every level of the organization will be held accountable. M Leslie Altizer is the Director of the CEB Compliance and Ethics Leadership Council which provides research and advisory support for compliance and ethics officers worldwide. Leslie also manages the CEB RiskClarity Service which is an employee perception tool measuring key cultural risks within a company. Leslie has nearly 10 years of experience supporting ethics and compliance teams with core program activities such as general program management, measurement & assessment, identifying & mitigating corporate risk, and training & communication strategies. Leslie has also spent a considerable portion of his career consulting with directors of Human Resources and ethics and compliance officers on effectively measuring employee perceptions of corporate culture and engagement. Prior to joining CEB in 2010, Leslie spent 4+ years with the Ethics Resource Center (ERC) managing their research and client-related survey tools such as the 2009 National Business Ethics Survey and the Defense Industry Initiative Benchmarking Survey. Leslie has presented research at numerous compliance and ethics events such as the Ethics and Compliance Officer Association, Practicing Law Institute, and the Society for Corporate Compliance and Ethics. He has a Bachelor of Arts degree in Psychology and a Master of Sciences degree in Industrial/Organizational Psychology.