Interview with Dr Simon Longstaff AO, Executive Director of The Ethics Centre

The Governance Leadership Centre speaks to Dr Simon Longstaff AO, Executive Director of The Ethics Centre, about the ethical issues facing Australian directors.

Dr Simon Longstaff AO is the Executive Director of The Ethics Centre. He serves on a number of boards and committees across a broad spectrum of activities, and is also a Fellow of the World Economic Forum, former Chairman of the International Advisory Board of the Genographic Project, and Deputy Chairman of the Global Reporting Initiative Board. Simon is a member of the AICD Governance Leadership Centre Advisory Panel. He has been named as one of the AFR Boss True Leaders for the 21st century.

Louise Pocock, Deputy Executive Director of the Governance Leadership Centre, recently spoke to Simon about the ethical issues facing Australian directors.

What do you believe are the key ethical issues that Australian directors and boards face today?

a) Culture

Firstly, Australian directors need to come to terms with the move by many groups, including regulators, to identify culture as a critical issue for boards. Many people seem not to realise that all culture is built on a foundation of ethics. Culture – the way that things “get done” – is the product of people making day-to-day choices: “I’ll do this because I think it’s good or better than the alternative”; “I’ll do this because I think it’s right rather than wrong”. The language of ‘good’ and ‘bad’, ‘right’ and ‘wrong’ is the language of ethics – a universal grammar that underpins all human choice and thus all that we make and do.

If you don’t manage culture and ethics in a conscious and active sense, the underlying structure and foundations of an organisation can begin to corrode or become corrupted. There’s also an opportunity cost. Research consistently shows that the way to unlock employees’ discretionary effort is by giving a clear sense of what the organisation stands for, and then by consistently acting in a manner which is in alignment with what has been espoused.

b) Foundations for incorporation and limited liability

Secondly, there are significant (and largely ignored) ethical issues concerning the legal privileges of incorporation and limited liability. The whole of corporate life ultimately depends on the maintenance of these privileges. Yet, without realising what is at stake, various actors are now eroding a general consensus that made possible the original innovations.

Shareholder activism, for example, has the effect of eroding the barrier that shields shareholders from the full consequences of corporate conduct. This barrier was erected in the 1850s and only after at least half a century of vigorous debate. At that time, the House of Commons in Britain agree that if shareholders were to enjoy the extraordinary privilege of limited liability then they must not interfere in the day-to-day management of a corporation. Instead, shareholders must allow directors, who bear ultimate responsibility for corporate conduct, to make decisions in the best interests of the corporation (a distinct legal person) as a whole.

It is not just shareholders who have misunderstood their role. The same is true of many directors. In recent years, a number of directors have started to assert that their principal duty of directors is to shareholders – or, more precisely, to increase shareholder wealth. With one exception (a change of control situation), this is simply not true. Directors are bound to act in the interests of the company as a whole, and the company is a separate legal person with interests that are not reducible to those of the shareholders.

Sir John Dunlop, one of the doyens of an earlier generation of Australian company directors, observed that the duty to shareholders, where it exists, is to shareholders in perpetuity, not to a particular group of investors at a particular time. Company directors have long understood that even if a significant majority of shareholders want a dividend to be paid, their duty to the company may require them to withhold the distribution of profits for purposes of reinvestment.

Unfortunately, the proper understanding of a director’s obligation has been watered down by that rhetorical phrase, “duty to shareholders”. One effect of this has been the adoption of dividend policies that are unproductive and ultimately unsustainable. This not only weakens companies – it is also the major restraint on national productivity. As the Productivity Commission has noted – it’s a lack of investment rather than a lack of labour productivity that is hampering the nation. Alas, too few boards have the stomach to act responsibly, risk their board seats and face down shareholders calling for dividends.

It’s time we returned to a true and proper understanding of the fact that shareholders do not ‘own the company’. They merely own a share of its issued capital – and may exercise the rights attached to each share.

c) Technology

The introduction of new, disruptive technology is producing significant ethical challenges in relation to obvious issues such as the destruction of current jobs and the unravelling of proven of business models. As Joseph Schumpeter noted, ‘creative destruction’ is not a bad thing – indeed it should be welcomed. However, it also needs to be managed with ethical restraint.

Technological change also has implications for social institutions that will have to rethink how authority is distributed throughout society

d) Trust and brand legitimacy

A further issue will be an increase in challenges about the legitimacy of institutions and even of brands. Questions of legitimacy go beyond those of trust. When trust declines, the loss can be offset by investing in (usually costly) methods of verifying and enforcing agreements. On the other hand, when legitimacy is lost – people will not deal with you under any circumstances or at any cost. The move from issues of ‘trust’ to issues of ‘legitimacy’ is part of what I think is the creation of a new commercial ‘ecology of meaning’ in which businesses are less defined by what they do then by what they stand for.

e) Diversity

The fifth ethical issue would be diversity (not just gender diversity – but in a broader sense). Diversity is the best antidote for the tendency of boards, at times, to become locations for ‘group think’.

As a matter of justice, women should be accorded their fair measure of representation at each board table. But also, there’s the practical utility of bringing to a board new forms of thinking, new ways of relating and new insights. Commitment to diversity of that kind is yet to be fully embraced. It should be. The concept of ’diversity’ should extend to variables that include: culture, gender, experience, disciplines, etc. Knowledge of the relevant industry and commercial acumen are essential ingredients – but a well-fashioned board will avoid the temptation to recruit people ‘in their own image’ as they will merely reinforce existing assumptions and prejudices.

Challenging as it may be, there is value in bringing in real ‘outliers’.

How do you see the relationship between business ethics and organisational performance?

A few years ago, The Ethics Centre and Beaton Consulting surveyed a large group of people (around 15,000 people) and found that if there is alignment between what an organisation says its stands for (its purpose, values and principles) and what it actually does, then people will give discretionary effort. When there is no alignment, they will withdraw. In fact, there have been countless studies that have shown that the root of sustained economic prosperity by corporations is to maintain that tight alignment. It goes back to the point I made earlier about trust and legitimacy.

This is particularly important in this day and age where strategic effects – the things that make or break a company – are no longer in the hands of the board or the CEO alone. If, for example, an employee does something problematic that is picked up by traditional or new media then it is often the case that the problem is escalated to the CEO and board. That is, anyone – at any level of a corporation – can generate strategic effects.

It has now become clear that you can’t control these risks by relying on rules alone. That is, there are serious problems that come with an overreliance on compliance. Regrettably, fearing personal liability, company directors have become some of the most prolific regulators in the land – creating internal systems of regulation and surveillance that are just as constraining as anything dreamt of by government. I think at the core of good governance is the duty of the board to ensure that individuals within the corporation, and the corporation as a whole, consistently make decisions that are good and right. Grant King, the CEO of Origin Energy, has put it in a disarmingly simple way: corporations that do well make more ’good decisions‘ than ’bad decisions‘; they do more things that are ‘right’ than ‘wrong’. Again, we find ethics at the root of good corporate governance.

What can directors and the board do to help facilitate an ethical organisational culture?

Boards should define and promote an ethical framework. The purpose of such a framework is to enable people, when acting on behalf of the corporation, to work from a common understanding of what makes a decision ‘good’ or ‘bad’, ‘right’ or ‘wrong’. That is what comes out of specifying values and principles related to a defining purpose.

Boards should ask management to include in board papers, as a matter of course, an account of the ethical issues arising from the organisation’s operations and in relation to the key decisions the board is being asked to make. This would include an analysis of which stakeholders are affected, and how actual and proposed conduct aligns with the organisation’s stated values and principles.

In particular, the board should guard against the development of ‘unthinking custom and practice’ – which is one of the great enemies of ethics. Most major instances of corporate wrongdoing are not the product of deliberately wicked people engaging in deliberately wicked conduct. More often than not, people drift into wrongful conduct and will look back and say, “I didn’t see it at the time … because everybody did it … because that’s just the way we did things”.

Can you think of a situation where the personal ethics of board members conflicted, and how that conflict was resolved?

Ethical conflicts happen fairly regularly; for example, whenever there are related party transactions, or where a director on one company has a conflicting duty owed to another. The language can be confusing. We tend to talk about conflicts of interest when, in fact, some of the most profound difficulties arise from conflicts of duty. Conflicts can be resolved by well-established processes: by people withdrawing to allow their peers (and others with a relevant interest) to make judgments. However, there comes a point where you become so conflicted that you can’t do anything of note, and you fail to be able to discharge properly the obligations that you owe to the company. In that case, you just have to step down.

The other area that I think is less commonly discussed is where an individual director has a personal conflict because they believe, from an ethical perspective, that the conduct of a company is ethically ‘wrong’. So, for example, you might be on the board of a company that enters into a joint venture involving exposure to significant levels of gambling. Or you can imagine conflicts arising when providing commercial services to, say, a tobacco company. It doesn’t take much imagination to conceive of examples where personal views may conflict with corporate conduct.

Then the question becomes this: to what extent is it reasonable for your own personal ethical position to inform your conduct at the board table, particularly where the company doesn’t have an ethical position that is in any way concerned about the things that trouble you as an individual. They key thing to remember is that it is the company’s ethics that must prevail – not those of the individual director. In the case of conflict you might seek to influence the company or you may have to walk away.

Finally, I think that there is the rarely discussed ethical issue arising out of directors’ understandable concern to protect themselves from personal risk. It is perfectly natural to want to protect oneself. However, in the absence of law reform to reduce the potential liability of directors, some people spend considerable time shoring up the defences upon which they might rely if ever called to account. This becomes their focus, rather than that of being productively engaged in promoting the interests of the corporation. If a board or if individual directors become overly concerned about protecting their own position, then it is inevitably counter-productive; at least in terms of good governance.

What approach might a director take if his or her personal ethics conflicts with the corporation’s plans or conduct?

The first question I’d have is “Does the corporation’s own ethical framework anticipate any of the issues that I find to be a personal matter of concern?” That’s part of your due diligence when you join a board – looking at what the company stands for and how it makes decisions. You don’t want to join an organisation completely committed to things which are diametrically opposed to your own perspective, not least because you won’t do a good job.

Secondly I’d ask, “Do my concerns have strategic implications for the company and for the successful operation of the company within its own ethical framework?”

If there is some room for you to raise the issue, I would say “I think there’s a strategic issue to consider. I have my own personal feelings, but I think it’s a matter we need to look at given the company’s existing ethical framework and its strategic interests”. If you invoke the company’s own framework, rather than focusing on what you personally feel, then it’s a legitimate thing to do.

If, despite your best efforts, your fellow directors rebuff you and are committed to continue on the current journey, then you may need to resign as a matter of good conscience. If the company really is so completely divorced in its strategic and ethical intent from your own ethical position, then it begs the question of why you joined the board in the first place.

Can you provide any guidance to assist directors and boards to make ethical decisions?

Boards should develop an ethical framework and ask management to include an account of the ethical issues arising from operations and decisions in all board papers.

A diverse board that brings in different perspectives can also assist in ethical decision-making. It is also important that the board has access to someone who understands ethics to act as a sounding board – whether they’re a member of the board or operating as an external adviser.

The board or individual directors should also consider engaging with specialists (such as The Ethics Centre) to obtain information on well-developed tools and techniques that can be used. There is, for example, a free national help line called Ethi-call for anybody who lives in Australia and wants help addressing ethical issues – whether personal or related to work. It’s a safe place where company directors can come if they’re looking for someone to assist.

Directors seeking ethical advice can contact Ethi-call on 1800 672 303.