Ethical challenges in Corporate Treasury

News coming out of the US recently raises a lot of ethics issues. Or, if recent events haven’t made you think seriously about ethics, they should have.

Damian Glendinning, Advisory Board Chair at CXC shares his views

We have seen a series of public officials, most recently federal prosecutors, resign from much sought-after and esteemed positions rather than file indictments which they judged to be politically motivated. Even more serious has been the situation off the coast of Venezuela, where many (American) observers view their own military’s actions as probable war crimes, or murder. This came on the heels of a very public – and very ugly – debate about whether soldiers should obey illegal orders. Whatever your politics, or your view of these events, it is difficult to imagine a scenario where it is a good thing that these questions are even being debated.

How did this situation arise, and what lessons should we learn from it? We will move from politics and war to areas which are more relevant to treasurers, and less politically charged – though ethics should not be a partisan political issue.

But, before moving on, it is important to note that the US government, and even their constitution, has structures and rules designed to ensure good governance. The whole system is built around separation of duties and powers, with a series of checks and balances. This structure should be very familiar to anyone who has ever been involved in internal controls and good financial governance. But – and this is the first lesson – these structures only work if people actually stand up and make sure the rules are applied. This can be unpopular – and with today’s social media, it can even be physically dangerous – but, if people start turning a blind eye, the system ceases to work. In the world of finance, examples abound, starting with the global financial crisis and the sub prime mortgage scandal.

Of course, as this is politics, supporters of the current US government may argue that there is actually a majority in favour of doing away with the old rules – but, again, there is a process for making that happen.

Treasurers face less existential threats. But they often encounter the very real problem that standing up to management can result in losing their job. Especially in countries with little to no unemployment benefits, and where health insurance is typically provided by the employer, this can be a serious issue, especially for people who financially support a family.

So – and moving to issues those of us who are not involved with politics have to face – what should treasurers do?

The first, and most obvious, move is self preservation. We have to accept that we have limited power to affect a whole corporation. Sometimes, the best thing is to simply move on: this may not solve the problem, but it does help the individual avoid facing an unacceptable choice between doing the right thing and paying the mortgage. And these issues have a tendency to become public, one day or another.

In turn, this raises the difficult question of when does this move become necessary.

First, we need to understand and accept that ethics is not an absolute notion. We all have different views of what is ethical, but our own views are often not entirely consistent. We all hate cheating in sports – but how many of us actually expect the players in their favourite football team (soccer for some!) to run after the referee and tell him he missed a foul and should award a penalty against them? If pressed, the argument will usually be along the lines that many decisions go against the team, so it is good to have one go the other way.

But this does not apply to all sports: in golf, for example, even the top players are expected to call a rules official and notify them when a foul has been committed. Failure to do this results in severe penalties, but also condemnation by fellow professionals. 

In other words, culture is a key issue. If the culture says anything goes, as long as the result is good, then that is exactly what will happen. Some corporate cultures actively encourage this approach, though not intentionally. We all recognise the important of Management by Objectives (MBO): a business needs targets, and needs to reward employees who meet or exceed them, and do something about those who fail. Performance matters. But, when applied without judgment, these systems encourage dishonesty: sales people are often left with a choice of the reason for being fired. Miss your targets, and you will certainly be fired. Cheat and behave unethically, and you will be fired – but only if you are caught. The result should surprise no-one. 

Of course, management will always say that incentives and targets must always be achieved ethically, and unethical behaviour will be punished. But they themselves face the same dilemma: they have to provide the shareholders with revenue and profit growth. How often do CEOs and CFOs report poor results saying that these happened because the company did the right thing?

We all know where this leads. Accounting always involves judgment. The accounting institutes have tried – and failed – to rein in what they call “cookie jar accounting”. Also, various measures can be taken to persuade customers to make a purchase in this financial year instead of the next one. A customer may be in financial distress, or a project may be in trouble: when do you start to recognise the loss or impairment? Depending on how we structure a financial loan, any related exchange gains or losses may go straight to equity instead of going through the I&E account and affecting reported earnings.

The problem with these actions – and the reason they continue – is that there is genuine debate about what is the correct course of action, and what is really right. If a customer really does buy the goods this year, then that is genuine revenue, even if business has been distorted. Also, reporting all exchange gains and losses on non monetary items in the I&E actually makes accounts less meaningful.

So – where do we draw the line? 

Before trying to answer that question, another excursion – this time into our attitudes towards the law. We are all proud of being law abiding citizens – but we all regularly break the law by exceeding speed limits. Authorities everywhere report that installing speed cameras, issuing fines and taking points off drivers slows traffic down. Conclusion: the fear of punishment achieves what a call to civic duty does not. Speed limits are often controversial, and even the authorities usually have a gradation for what they consider to be minor, versus serious, offences. But the fact remains that, in our minds, not all laws are created equal.

Accounting and commercial gymnastics which improve reported results are a fact of life, and any processes which eliminated them completely would suffocate business. But they are like alcohol: taken in moderation, they are part of life in most societies. But, like alcohol, excess can create a dependency which leads to disaster. Corruption is bad, but entertaining clients is essential for smooth business relationships.

There is no hard and fast line which cannot be crossed. But, in real life, there are red flags. These can include when debatable practices become essential to meeting objectives. But a bigger red flag is when management starts to condone, or even promote, these activities.

Just as in sport, there are cultures which tolerate cheating and others which don’t, so there are companies where anything goes, and ones where unethical behaviour will be called out and sanctioned. In some companies, complaining about unethical behaviour leads to punishment against the person making the complaint; in others, that person is protected. In some companies, internal audit is toothless; in others, their findings and recommendations are taken seriously, even when senior management is involved, and the head of internal audit has regular meetings with the audit committee of the board of directors, without management being present. 

Every treasurer knows where their company stands on this spectrum. We also know where this behaviour ends: in every financial scandal, the same root causes emerge. Management ignores and even suppresses complaints, people take an overly broad view of what is acceptable – and sometimes, legal opinions based on dubious arguments justify what common sense says is not acceptable. But it is not in anyone’s interest to be part of this kind of scandal when it becomes public.

An important ingredient in creating the right culture is leadership. It takes courage, and leadership, to say no. But, often, that is precisely what people are looking for. If a sales person has a dubious request from a customer, they may hesitate: they know they should refuse. But, if they are going to be alone and facing criticism, they will probably accede. If there is a strong refusal, backed up by management, the outcome will be different – and the sales person will almost certainly be relieved.

Conclusion: ethics is a complex issue. We cannot give a precise definition, and, if we are honest, we have to admit that we are often quite flexible. At the same time, there are clearly situations which go too far.

In practice, there are nearly always warning signs when things are headed in the wrong direction: these are mostly to do with the corporate culture, leadership, and how management behaves. Treasurers are in a unique position: they often have good reason to say no to various transactions. Management’s reaction is a key litmus test for where the organisation stands.

We all understand that no single person can change a corporate culture. But we can avoid being on the ship if we know it is not seaworthy. 

This is not to paint an unduly negative picture of corporate ethics. Most companies have good ethics cultures, and follow acceptable rules and norms. But this does not mean to say exceptions do not exist – they do. Above all, we should never assume that the processes and structures put in place will work and be effective: they depend on people having the courage to apply them, especially when this is difficult.

We can all recognise a red flag when we see it. We all have a duty – to ourselves as well as to the organisation – to call these things out before they become standard practice. That is the only way checks and balances actually work.