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Strategic Integrity Management as a Dynamic Capability

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Abstract and Figures

Increasing societal expectations regarding responsible business conduct as well as an increasingly fierce enforcement environment are placing integrity and compliance highly on the list of management priorities. However, although many companies are investing serious efforts into compliance programs and are increasing the headcount within their compliance organizations it seems to be striking that severe ethical breakdowns still happen on a very regular basis. The reason may well be that strongly relying on classical elements of compliance programs to prevent misconduct such as establishing numerous policies, strengthening awareness training and increasing monitoring mechanisms works like trying to win the Tour de France with flat tires. Typically, structural causes are the driving forces behind systemic misconduct. These include; unbalanced incentives systems that determine bonuses, salary increases or career progression without any consideration of moral behaviors; a lack of responsible leadership; or a climate in which speaking-up is not an accepted practice but instead, represents a career risk that could lead to repercussions. Therefore, we suggest that in the interest of further preventing and reducing cases of misconduct a more analytic and less ideology driven discussion about the real and systemic root causes of integrity issues needs to take place. Unethical conduct should not just be viewed as lack of integrity or lack of certain character qualities of some individual employees. Such a perspective does not recognize the complexity of most corporate integrity or compliance issues. Research has shown that the apparent frequency of ethical misconduct is being caused by organizational factors that create enormous psychological pressures on individuals. This then leads to situations where even managers who are considered highly moral deviate from everyday ethical norms. People that constantly claim that compliance failures are mainly caused by the ethical misconduct of individuals – let’s call tem bad apples – and simplistically refer to the lack of personal integrity seem to confuse the real root causes. They may generate some kind of moral alarm but are not helpful in terms of finding systematic and sustainable solutions to the problem. In this chapter we describe how dynamic integrity management processes can be integrated into the "game-changing" organizational systems in order to avoid negative conduct. Further, we will build a road map of how integrity management can actively drive positive effects on firm performance and we describe how integrity management can be used dynamically as a strategic tool that creates positive effects on firm performance.
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Electronic copy available at: http://ssrn.com/abstract=2064981Electronic copy available at: http://ssrn.com/abstract=2064981
1
Strategic Management in the 21st Century
Tim Wilkinson (Eds.), Praeger Publishers 2013 (in print)
STRATEGIC INTEGRITY MANAGEMENT AS A DYNAMIC CAPABILITY
*
(In Print)
Michael Fuerst, PhD
Manager Integrity & Compliance, and Corporate Citizenship
at Novartis International AG
Switzerland
michael_fuerst@gmx.de
&
Andreas Schotter, PhD
Assistant Professor of Strategic Management
Thunderbird School of Global Management
1 Global Way
Glendale, AZ 85306, USA
+1.602.978.7139
andreas.schotter@thunderbird.edu
October 2011
*
When not otherwise indicated, statements made in this article represent the personal opinions and perspectives of
the authors and not of the affiliated organisations.
Electronic copy available at: http://ssrn.com/abstract=2064981Electronic copy available at: http://ssrn.com/abstract=2064981
2
Abstract
Increasing societal expectations regarding responsible business conduct as well as an
increasingly fierce enforcement environment are placing integrity and compliance highly on the
list of management priorities. However, although many companies are investing serious efforts
into compliance programs and are increasing the headcount within their compliance organizations
it seems to be striking that severe ethical breakdowns still happen on a very regular basis. The
reason may well be that strongly relying on classical elements of compliance programs to prevent
misconduct such as establishing numerous policies, strengthening awareness training and
increasing monitoring mechanisms works like trying to win the Tour de France with flat tires.
Typically, structural causes are the driving forces behind systemic misconduct. These
include; unbalanced incentives systems that determine bonuses, salary increases or career
progression without any consideration of moral behaviors; a lack of responsible leadership; or a
climate in which speaking-up is not an accepted practice but instead, represents a career risk that
could lead to repercussions.
Therefore, we suggest that in the interest of further preventing and reducing cases of
misconduct a more analytic and less ideology driven discussion about the real and systemic root
causes of integrity issues needs to take place. Unethical conduct should not just be viewed as lack
of integrity or lack of certain character qualities of some individual employees. Such a
perspective does not recognize the complexity of most corporate integrity or compliance issues.
Research has shown that the apparent frequency of ethical misconduct is being caused by
organizational factors that create enormous psychological pressures on individuals. This then
leads to situations where even managers who are considered highly moral deviate from everyday
ethical norms. People that constantly claim that compliance failures are mainly caused by the
ethical misconduct of individuals – let’s call tem bad apples – and simplistically refer to the lack
Electronic copy available at: http://ssrn.com/abstract=2064981Electronic copy available at: http://ssrn.com/abstract=2064981
3
of personal integrity seem to confuse the real root causes. They may generate some kind of moral
alarm but are not helpful in terms of finding systematic and sustainable solutions to the problem.
In this chapter we describe how dynamic integrity management processes can be
integrated into the "game-changing" organizational systems in order to avoid negative conduct.
Further, we will build a road map of how integrity management can actively drive positive effects
on firm performance and we describe how integrity management can be used dynamically as a
strategic tool that creates positive effects on firm performance.
4
Introduction
In recent years integrity and compliance management has developed beyond being a
reactive and rather static mitigation activity for correcting or minimizing negative effects from
ethics breaches or other managerial misconducts. Today, leading firms deploy integrity and
compliance management approaches that proactively influence organizational core processes and
employee behaviors. There are two main reason for this change including; increased pressures
from outside of the firm to become better corporate citizens; from within the firm, driven by
more educated and diverse employees especially from generations ‘X’ & ‘Y’
1
. Both trends are
reactions to the many publicized cases of company misconduct such as corruption (e.g. Siemens
2008), accounting fraud (e.g. Enron or Lehmann Brothers), and human rights violations (e.g.
Shell) over the last decade. We therefore suggest that in the interest of preventing and reducing
those cases in the future a more analytic and less ideology driven discussion about the real and
systemic root causes of integrity issues needs to take place. We describe how leading firms use
integrity management dynamically as a strategic tool that creates positive effects on firm
performance.
Unethical conduct should not just be viewed as lack of integrity or lack of certain
character qualities of some individual employees. Such a perspective does not recognize the
complexity of most corporate integrity or compliance issues. Research has shown
2
that the
apparent frequency of ethical misconduct is being caused by organizational factors including
corporate cultures that create enormous psychological pressures on individuals. This then leads to
situations where even managers who are considered highly moral deviate from everyday ethical
norms. Even more importantly structural causes are typically the driving forces behind systemic
misconduct. These include; unbalanced incentives systems that determine bonuses, salary
increases or career progression without any consideration of moral behaviors
3
; a lack of
5
responsible leadership
4
; or a climate in which speaking-up is not an accepted practice but instead,
represents a career risk that could lead to repercussions
5
.
Jennings
6
uncovered some of the reasons for the collapse of companies based on ethics
issues in her book titled: “Solutions to the Corporate Integrity Quandary.” Companies need to be
more proactive in integrating general organizational processes and structural designs rather than
being reactive and defensive, solely focused on mitigation and damage control. In this chapter we
describe how dynamic integrity management processes can be integrated into organizational
systems in order to avoid negative conduct. Further, we will build a road map of how integrity
management can actively drive positive effects on firm performance.
The Source of Corporate Integrity Issues
The popular claim that organizational compliance failures are mainly caused by the ethical
misconduct of a few individuals, often referred to as ‘bad apples’, does not really address the
actual structural problem of integrity and compliance failures
7
. At best, this is moral finger
pointing, which is not helpful in identifying the underlying causes in a systematic and sustainable
way. In order to adequately identify and judge ethical misconduct it is not enough just to focus on
motives and the lack of individual level character traits followed by post-hoc punishment of the
alleged ethics offenders. We argue that organizations should base their compliance processes on
deep contextual understanding and on clearly defined organizational integrity drivers and on
interdependencies of these two in order to gain control over threats to misconduct in
organizations
8
.
Another critical point within the ethics, compliance, and integrity debate is ambiguous
terminology. Here especially, the term ‘compliance’ seems to be problematic for practical design
and implementation of integrity and compliance management programs. The reason is that the
6
existing terminology is at best vague and interpretations are very scattered, context dependent
and often not easy to understand across the entire organization. For example, does compliance
mainly refer generically to the compliance with legal, industry specific or internal standards and
values or are there other norms, standards, and values that are not explicit or not located within
the organization itself? If there are other norms, what are those and what do they mean to the
daily operation of organizations? For example, should there be a formal integrity and compliance
manager who takes care of the issues and is this manager than explicitly responsible for detecting
and punishing corruption, bribery, accounting fraud, privacy, quality, regulatory, IT compliance
breaches, human rights, or anti-trust violations? Or should compliance management be not so
much an issue-driven task but instead a programmatic management-approach that supports the
development of values-driven best practices and ethical behaviors from all internal and external
stakeholders?
9
We use the term compliance in an alignment and evaluation sense and we use the
term integrity to refer to an overarching, behavior driving principle that is values driven and that
incorporates a specific set of managerial and organizational values across the entire organization,
while taking environmental dynamism into account. By environmental dynamism
10
we refer to
the increasingly more prevalent phenomenon that organizations have to constantly adjust to
multiple institutional and cultural environments across diverse geographic and demographic
boundaries that are often transitional, as in the case of emerging markets. But no matter how a
corporation frames its integrity and compliance program, a values-driven approach instead of a
rules based approach is the most effective strategy to empower employees in an organization to
behave with integrity in critical situations, systemically, effectively and in compliance. This then
leads to higher, rather than lower, levels of ethical conduct
11
. So the question remains, what
should a blueprint for such an integrity management system look like?
7
Positioning within the Organizational Context
Integrity management should not just be viewed as a misconduct-limiting organizational
instrument. Instead, strategic integrity management should be used to foster ethical behaviors that
ultimately drive firm performance by stimulating and empowering positive behaviors. Integrity
management then becomes an active part of every core process of an organization that develops
shared values along the organization’s strategic priorities, its core competencies, and among its
internal and external stakeholders. This argument builds on the notion of connectivity between
integrity management concepts and the debate about the external social responsibilities of
organizations.
Effective integrity management is forward looking, beyond philanthropy or charity, in a
direction in which social responsibility is perceived as a concept that drives change through
economic means. Its processes serve as a platform for disruptive innovation in the social context
within an organization
12,13
.
The allocation of responsibilities for compliance to specific groups or
individual actors and functions has an intermediate effect on the design of individual compliance
systems. Integrity management then becomes a dynamic capability that aligns, shapes, extends or
modifies an organization’s resources and processes towards higher levels of performance
14
. We
suggest an integrated approach as illustrated in Figure 1. Doing business with integrity means
doing the right things. It drives performance through building a culture of integrity, managing
risks, strengthening internal and external reputation, and improving competitive advantage.
8
Figure 1
Integrity Management and Performance
15
Five reasons to invest in an integrity management program
Sustaining and increasing organizational competitiveness is more and more linked with
the willingness and ability of managers to build business models along ethical principles and to
contribute to positive societal change.
16
If we revert to the basic assumptions of institutional
17
and organizational economics
18,19,20
it becomes obvious that ethical values of individuals,
organizations and societies are always basic elements of the governance and control mechanisms
of any transaction between individuals or organizations. An economic transaction entails a set of
informal constraints that are being caused by the incompleteness of markets. Contractual
arrangements, therefore, are an integral part of a functioning transaction. Williamson
21
used the
term atmosphere in this context, without specifically referring to values, morality or ethics. This was
Integrity
drives
performance
Do the
right thing
Build a
culture of
integrity
Improve
competitive
advantage
Strengthen
reputation
Manage
Risks
9
later done by Wieland
22
, who introduced a theory of the ethics of governance. The structures that
govern economic transactions contain explicit values, morals, and/or cultural preferences that can
be theoretically conceptualized as formal and informal institutions. In this theoretical approach
specific mechanisms exist on different governance levels such as law, societal and organization-
specific cultural patterns, or formal control and management mechanisms within an organization.
The ultimate objective behind these formal and informal governance structures is to stabilize or
to increase the mutual gain of an economic and social transaction between different transaction
partners
23
. In this theoretical scenario the development of ethics becomes endogenous rather then
exogenous to the economic process
24
. This means that moral issues are conceptualized as a
genuine part of the classic economic problem to overcome the scarcity of resources and
competencies in a competitive setting
25,26,27
.
A crucial element of the individual or collective ethical values, and the relevant
governance structures that establish, promote, and enforce adherence with these values, is a set of
moral, or ethical resources that have an economic value, while having an impact on the initiation,
enforcement and the monitoring of a transaction.
28
The moral resources of a company that represent the foundation of its culture and identity
work as a filter for the perception and the selection of risks that managers take in the context of
business opportunities. These moral resources also serve as governance parameters for
management, but only if these parameters are properly embedded in the governance mechanisms
of the organization. Integrity management functions as a moral, relevant governance
mechanism
29
. It plays a critical role in this context as the values and qualities of individuals ‘and’
organizations determine which strategic options are perceived and considered as being
appropriate and how these and subsequent strategic objectives will be achieved throughout a
firm’s value creation process.
10
On a more tactical level, this leads to five dominant reasons for investing in integrated,
proactive and dynamic integrity management, including; 1) recognizing ethical responsibility and
safeguarding the integrity of the company
30
; 2) generating new growth opportunities through
innovation and performance driving integrity activities
31
; 3) protecting and improving the
reputation of a company
32
(including maintaining attractiveness for current and future employees
in mind); 4) establishing values-sensitive risk management that focuses on systemic risk
mitigation drivers
33
rather than tactical risk minimization and; 5) fostering a culture of integrity
that systematically enables employees to behave in line with ethical expectations and standards
34
.
We suggest that these five dimensions will strengthen the business case for integrity and
compliance management particularly if it is closely linked and aligned with the strategic priorities
of a company.
While the general recognition of ethical responsibilities and the protection of reputation,
as well as the management of risks, are often communicated in corporate brochures and annual
reports, specific objectives of integrity and compliance programs or integrity management
processes are still only rarely identifiable in practice. There is often a discontinuity between
communicating expectations of ethical conduct in theory, and managerial actions in practice.
Instead, managers often argue that illegal or illegitimate behavior is often unavoidable because
competitors do not consider legal or ethical standards to the same extent and therefore a company
would be at risk of losing important contracts or potential customers would not consider the
firm’s products or services if certain requests were not accepted. These same managers argue that
refusing requests that are in conflict with ethical behavior leads to lower levels of
competitiveness and ultimately threatens firm survival. In our research we often hear the
aphorism: “when in Rome do as the Romans do!” Examples of this perspective are vast. For
example, executives at Chiquita Brands International Inc. argued along the same lines when they
11
tried to justify illegal payments to the FARC and AUC terrorist organizations in Colombia, who
have killed thousands of innocent people with weapons purchased from these payments
35
.
Another example is the bribery scandal that recently surrounded Germany’s Siemens AG, one of
the leading global conglomerates in Europe and often touted as Germany’s General Electric
(GE). In early 2007, a court convicted two former Siemens managers of paying 6 million euros in
the late 1990s and early 2000s to help the company win contracts from an Italian energy
conglomerate worth approximately 450 million euros. The company had to pay a 38 million euro
penalty. The following year, Siemens accepted a USD1.34 billion fine when investigators
identified dubious payments of more than 1.3 billion euros over a period of four years in the early
2000s
36
. While in the Chiquita case managers avoided prosecution and only the company paid a
fine to the United States Justice Department, in the Siemens case, managers were penalized
individually for criminal misconduct.
Despite the obvious negative effects on the bottom line when caught, some questions
arise. Why should business limit itself to just imitating competitor conduct? Is it not a basic
element of doing business and of being entrepreneurial to differentiate oneself from competitors?
Furthermore, bribing someone to get a contract just means paying for closing a deal, which
means that the contract is not based on the value proposition of the related product or service.
When those practices are systemically extended over a longer period of time and then become
culturally accepted within the organization, the interest, appetite and ability of individuals to
innovate will gradually decline. This then leads to lower levels of competitiveness and an even
greater dependence on questionable business practices.
We argue that an integrity management program that addresses and integrates ‘best
practices’ systematically into daily operations and makes them part of a shared managerial
agenda, daily routines, and explicit performance rewards
37
will not only eradicate bad behaviors
12
it will improve overall firm competitiveness. It will also help to overcome structural obstacles to
innovation and differentiation, as integrity management becomes a competence enhancing
organizational capability. Prerequisite for the ability to realize these advantages is first the
recognition that ethics or ethical behavior is not a hassle and that the investment in an integrity
management program is not just a checklist item that protects the firm’s license to operate.
Instead, integrity management is an opportunity to realize greater advantages for the business and
the societies in which it is embedded. Ethics and subsequently integrity management is a
persistent force that challenges the organizational status quo. Second, a concept is needed which
allocates the responsibilities for ethical behavior efficiently and which links integrity
management with the core organizational activities, the key resources and the business strategy of
the organization.
Basic principles for an effective Integrity Management Program
In this section we will discuss which specific factors truly effective integrity management
should be based on. We use the descriptor truly effective in this context in a slightly provocative
manner. The reason is that having observed so many ethical failures in companies which claimed
to have effective compliance programs aligned with the requisite legal systems (e.g. United States
Sentencing Guidelines), it appears to us that such programs did not address the key drivers that
affect managerial behavior. Later, we will suggest an organizational framework and a series of
principles for an integrity and compliance management program. The specific functional
responsibilities for integrity management can be drawn from these principles.
One of the most essential responsibilities of the executive team and the board of directors
of a company is to establish firm specific, values-based standards that are relevant and
understandable by employees. Even the most comprehensive policy framework will not
13
necessarily assure responsible behavior when the standards are written in technical legal language
only and when they are too lengthy for employees to comprehend or even read. It typically drives
negative reactions in employees including hostility and sarcasm when it becomes obvious that
policies were established with the sole purpose of representing a legal line of defense for the
company instead of being drafted for the purpose of facilitating good decision-making.
It is the responsibility of every single individual within the firm to follow these standards
and to make decisions that are in line with the internal values and standards. The executive team
and operational management are then ultimately responsible to promote, monitor and enforce the
adherence to these standards. This responsibility cannot be delegated or outsourced, especially
not to an integrity and compliance department because ensuring compliance is not the
responsibility of a separate department with, often, only limited insights due to incomplete
information and sometimes limited execution power. Instead, in the interest of accountability, the
monitoring responsibility rests with the top management of the organization.
Consequently an integrity and compliance department should not approve or sign-off on
business transactions for integrity compliance rather, it should be called upon by management for
consultation and advice in dilemma situations or in cases of ethical doubt. Also, the integrity and
compliance department should not be made responsible for monitoring specific business
transactions, as proposed in many descriptions of the roles and responsibilities of the integrity
management function
38
because we believe that integrity management and compliance are
genuine management tasks in the execution of core business and daily transactions therefore
should not be delegated away.
Similar to the overarching responsibility of top management, every department should be
responsible for ensuring that business is being conducted in line with internal standards, values
and laws. Delegating this monitoring is bad practice because separating business process
14
responsibilities and integrity and compliance responsibilities increases compliance risks
39
. In
such a scenario the risk preferences of an individual actor would be split from rewards which
might be generated if the business objectives are achieved. This is fundamentally opposite to the
economic paradigm that suggests that earnings have to be allocated where the risk is taken for a
specific transaction. The global economic crisis of 2008, which was triggered, to large extend, by
a huge decoupling of risks and rewards in financial transactions and bonus systems
40
, made it
clear why an integrated approach is essential. Department managers should be actively supported
in the task of ensuring responsible business practices by functions as they develop and implement
processes, systems and tools to train employees in responsible behaviors and to audit compliance
with internal standards and regulations.
The responsibility of the integrity and compliance department is to develop an integrity
program that supports management in ensuring ethical and legal business conduct. Such a
program is a catalyst for establishing, promoting and enforcing ethical standards through
adequate processes and activities. Its success is based on ethical leadership, executed by all
relvant layers of management, and by an effective organizational culture that includes a climate
of speaking up, skills training to balance ethical, legal and economic factors, values-based pay for
performance, and ethics sensitive recruitment and career progression.
In 2008, KPMG
41
, in a large sample study, identified basic drivers of misconduct
including; pressure to achieve business goals; being paid for just making the numbers; as well as
a general lack of specific evidence for the fact that following ethical standards was being taken
seriously. When these drivers are combined with the fact that most employees see training as
being useful for understanding pertinent integrity standards, and that few firms provide such
training, this problem adds to the persistent and surprisingly frequent occurrences of new
integrity crises.
15
While it is the responsibility of management to execute, an effective integrity program
should be developed by the integrity and compliance department and be enforced in cross-
functional efforts that are closely linked with business processes. This means that the
accountability for specific activities within such a program is part of responsibility of the
different support functions such as HR, legal, audit an’ the core business functions, including
sales, marketing, operations and other such areas. If we apply these principles and responsibilities
for the individual actors in the integrity and compliance system within a company we can
structure them along the following dimensions:
Top Management:
a) Developing values based mission, vision and strategy.
b) Developing an organizational structure that allows an integrated approach to integrity
and compliance management.
c) Enabling employees to make ethical decisions by positively influencing the
organizational context in which these decisions are taken.
d) Empowering critical integrity and compliance functions to be effective in developing
and implementing integrity and compliance driven processes.
e) Holding itself and its members explicitly accountable to these standards (lead by
example).
Individual Employees:
a) Actively adhering to laws and relevant internal values and standards.
b) Supporting others within and outside the organization to act on the values and
standards.
c) Actively speaking up in cases of non-compliance or ethics violations.
Business Line Management:
a) Enabling employees to take ethical decisions by positively influencing the
organizational context in which these decisions are taken.
16
b) Promoting and enforcing adherence to laws, values and standards through responsible
leadership.
c) Assessing compliance with values and standards in performance management and
incentive programs.
d) Fostering a speak-up climate.
e) Monitoring and sanctioning misconduct as well as implementing audit
recommendations.
Support functions (HR, Finance, Legal):
a) Establishing and maintaining function-specific standards, ensuring consistent
behavior with internal standards and laws.
b) Establishing processes to enforce function specific standards and support
management in implementing them.
c) Identifying functional areas of risk.
d) Monitoring the implementation status of the processes.
Internal Audit:
a) Evaluating the effectiveness of internal control systems and identifying areas for
improvement.
b) Conducting audits and agreeing with line management on corrective actions.
c) Reporting the audit results and conclusions to the board of directors.
Integrity and Compliance:
a) Developing and managing the integrity program which supports top management in
adhering to and enforcing ethical conduct.
b) Supporting the board of directors and top management in establishing and maintaining
a code of conduct and other relevant business conduct standards.
c) Supporting line management in implementing the code of conduct, supporting other
functions in establishing standards.
d) Training of employees on good business conduct standards and responsible behavior.
e) Advising management and employees in ethical dilemmas.
17
f) Monitoring the implementation status of the integrity program.
g) Conducting risk assessments with regards to the relevant drivers of risk and advising
management on mechanisms to deal with these risks.
h) Reporting independently to the board of directors and the executive team.
Complaints handling department:
a) Receiving all reports about suspected and actual misconduct and assigning
responsibilities for investigation.
b) Reporting to the board of directors and top management.
Basic principles for an organizational set-up of an integrity and compliance department
The common approach of having an integrity and compliance department sidelined from
actual organizational processes has a tendency to absorb the responsibility for adherence to
integrity standards or laws without focusing on the real drivers of unethical behaviors. Instead,
such a disintegrated approach often leads to large efforts and investments into formulaic
awareness-training programs, certification processes and monitoring mechanisms, which only
increases bureaucracy without having any real effect on business conduct as such. This problem,
linked with ongoing cost increases for compliance over the past decade
42
with, at the same time,
not much of an impact of these programs on the frequency or severance of misconduct in general,
supports our call for a sounder integrated prevention focused approach, instead of a purely
control and mitigation focused approach.
As pointed out earlier, the KPMG
43
study identified that pressures to achieve short-term,
purely profit maximizing business objectives at any cost in combination with flawed managerial
reward structures that support these short-term goals, and a lack of credible signals from
management that ethical standards have to be taken seriously are the main reason for managerial
misconduct. However, most organizations’ compliance activities are rather static and have not
18
addressed the dynamic changes in the business and social environment. These static approaches
are often limited to communication, A (one time) establishment of standards, awareness training
on the code of conduct, and post-hoc investigations into suspected or actual cases of misconduct.
In addition, the integration of the code of conduct and business conduct standards into actual
incentive schemes is only institutionalized in less than one third of all organizations
44
.
This indicates that a deeper recognition of the real drivers of behaviors and root causes of
systemic ethical misconduct has not been widely adopted as part of the managerial mindset or the
actual compliance framework in most organizations. One of the reasons for the lack of adoption
might be that it is very difficult to demonstrate the business case for an integrity and compliance
program because of a lack of tangible success stories. The difficulties in measuring the impact of
those programs on profitability further complicate its general acceptance. This can result in cases
where entire integrity and compliance programs are at risk of being eliminated when cost cutting
needs arise. We therefore argue that integrity and compliance management should become a set
of support capabilities that drive firm performance dynamically. We specifically argue for a
dynamic capability perspective when it comes to integrity and compliance management.
Recent scholarly works in the strategic management field
45
have pointed to the importance
of dynamic capabilities in the face of increasing environmental turbulence. Dynamic capabilities
are strategic processes used to create new competencies and to mobilize resources effectively for
the development of competitive advantage. Reconfiguring existing resources into new
competencies is the core logic underlying the dynamic capabilities perspective. However, the
value creation notion that underlies the prevailing cognitive assessment of whether a resource or
a dynamic capability is recognized as valuable in the sense of creating a sustained competitive
advantage seems to make integrity management ineligible to be considered valuable. Often
integrity and compliance activities are categorized as costs; hence a value reducer instead of a
19
critical capability that enables other resources and capabilities to create value in a sustained
fashion. The net effect of integrity activities is often not explicitly accounted for.
Elements and core activities of an effective Integrity and Compliance Program
The values and integrity standards of a company give a clear sense of direction and
support for employees in their daily work. However, the reality is that the transformation of
ethical principles into the daily business of a company will not be realized just because integrity
and compliance standards are formally established and codified. Execution requires rather more
including, the effective integration of these standards into the systems and processes that are
influencing the behaviors of individual employees despite the competitive pressures created by
the external environment. We will now describe the key elements and activities that we recognize
as being critical for the success of an effective integrity and compliance management program.
As a practical road map for this approach we apply the Novartis’ integrity and compliance
program
46
, which has been developed by one of the authors of this chapter
47
. Novartis is a world
leading Switzerland based healthcare company that operates globally.
In order to achieve effective integrity and compliance management, it makes sense to
establish a values-based and behavioral based integrity and compliance program. The basic
purpose and role of such a program is to support the management of a company in ‘giving life’ to
its values and standards. Such a program should be process-driven. It should focus on the
processes that influence the key behavioral drivers and it should consist of three core elements
including; establishing, promoting and enforcing the integrity standards of a company. This is
achieved through specific processes that include elements required by U.S. sentencing guidelines
but go clearly beyond the ones mandated. Such an approach is conceptually and materially very
different compared to the ‘traditional’ rules-based, static compliance approach. The specific
20
processes include responsible leadership; pertinent incentive schemes; training of skills for
responsible and ethical decision-making; legal, integrity and economic performance based
thinking when making decisions; and a speaking-up culture in which employees can safely raise
concerns or bring-up innovative solutions to the integrity or compliance challenges of the
organization. The conceptual core of such a program is that the success and the decrease in the
number of misconducts is not just a function of the management of specific issues such as anti-
corruption, anti-trust or privacy, activities involving communication, or whistle blowing.
Although these processes and activities are important, it is critical to understand that the
management of the organizational context and the main behavioral drivers are crucial elements
when promoting and enforcing ethical behaviors successfully. It should be an integrated
capability that drives processes towards higher performance through values based management.
Figure 2 illustrates the integrated framework used by Novartis.
21
Figure 2
An integrated Integrity Management Framework
48
Establishing integrity standards
The task to generate and build trust can only be mastered successfully if the behavior in
specific transactions is based and guided by high integrity standards. Such standards are relevant
for encouraging employees to behave responsibly and in line with the values of a company. This
is especially true in gray areas that are characterized by ambiguous facts, high economic or
financial pressures, and different cultural paradigms.
It is recommended that integrity standards, such as a code of conduct or issue specific
policies and guidelines, are being developed from and linked with the mission and the core values
of the organization. In addition, it is paramount (while today still not necessarily reality) that
these policies and guidelines are not phrased in an extremely technical, complex and too detailed
22
language that cannot be understood easily by employees. They should be written in simple
language that can be comprehended quickly while providing issue-specific principles that can be
applied directly but with enough managerial discretion and that guide behaviors in different local
situations or circumstances. On the highest level, a code of conduct should provide answers to
two questions
49
:
1. How can the company meet the growing ethical and legal expectations in increasingly
dynamic societies and markets?
2. What are the key behavioral strengths than can improve competitive advantage and
differentiate the company from competitors?
A code of conduct clarifies to all relevant internal and external stakeholders which
standards guide behaviors. It communicates the commitment of the firm towards responsible
business practices. A code of conduct reduces the likelihood of systemic misconduct by clearly
framing behaviors that are not allowed and by linking behavioral expectations and conduct with
performance management. It stimulates positive behaviors and it supports the positive branding
of a company both, internally and externally. A code of conduct helps employees to understand
and manage cultural diversity, which than leads to higher levels of cross cultural collaboration. In
addition a code of conduct enables operating with simplicity since fewer layers of control and
supervision are needed.
Whereas the first question is mainly referring to the risk management, the second question
addresses performance impact. Both provide a clear sense for the purpose of a code of conduct.
We call this the ‘commonly agreed frame of action’ that reflects ethical and legal expectations of
all stakeholders. It aids in reducing risks caused by misconduct and drives performance.
However, the sheer existence of standards does not guarantee that such standards are relevant and
23
applied. Therefore, code of conduct and integrity standards have to be incorporated into all
critical management processes in order to drive and foster responsible behaviors and the values
compliant execution of daily routines.
Promoting responsible behavior
An integrity management program should aim to develop and promote an ethical culture
through responsible leadership by the management of a company. In addition, performance
should be evaluated based on two dimensions including; individual business task execution
effects on the bottom line of the company and secondly on how these outcomes have been
achieved. Tools like the Balanced Score Card
50
approach, or the Total Performance Excellence
Approach
51
described in the chapter on management frameworks in this volume are useful
practical enablers of integrity driven rewards schemes.
Responsible leadership
One of the tasks of the leadership of an organization is to communicate the company
standards and to demonstrate their importance and the adherence to these standards in daily
operations to all employees and other stakeholders including suppliers, customers, investors,
regulators, etc. Leadership should always promote and follow the highest ethical standards pro-
actively. The reason is, that there is nothing that provokes more contempt in a company than
seeing managers making fancy presentations about the importance of values and ethical standards
but than these same managers fall short ethically in their own conduct. In addition, a highly
ethical manager that acts in line with critical values as an individual but fails to communicate
those values is not empowering his colleagues and subordinates to act ethically themselves.
52
24
Furthermore all management levels should generate an atmosphere where employees can
speak-up, raise concerns and discuss integrity dilemmas before these dilemmas turn into negative
outcomes for the entire organization or parts of it. Management should actively encourage all
members of the organization to develop innovative ideas and business solutions based on
integrity and compliance standards. The latter seems to be especially important in the recent
debate about the rise of integrity management as a driver of superior firm performance. The
reason is that recent shifts in general perceptions about ethical standards force companies to
include the assessment of economic and societal outcomes as part of their daily routines. Integrity
management that builds on this premise contains very often undiscovered and unrecognized
potential to drive competitiveness and differentiation. To stimulate a climate of open discussion,
management should establish speaking-up programs that could include intranet-blogs and
informal cross-functional, -departmental and –hierarchical meetings on a routine basis. In
addition, active open discussions about cases of misconduct, actions taken and lessons learned
should take place in a positive rather punitive atmosphere.
Objectives and Incentives Integrating values and integrity standards into performance
management instruments
One of the most important elements of an integrity management program is the anchoring
of an organization’s values and standards in the performance management and remuneration
system. The reason is that reward driven systems are the most effective mechanisms for
influencing individual behaviors. To be clear, incentives and rewards do not only refer to
monetary or material incentives or rewards. Individual managerial motivation can be fostered by
a multitude of different factors. Incentive schemes should be adapted to the needs and preferences
of individuals and could include non-monetary wards like for example sabbaticals, training or
25
development or other recognitions. In some countries, like in China, these rewards are highly
valued since access to knowledge and training is not readily available outside firms.
The recent global financial crisis has shown very clearly that one of the most crucial driver
for the big integrity risks is not the fact that some few employees behave notoriously unethical
(‘bad apples’). In fact this kind of crises are being fueled through systems that measure
employees only along one parameter that is just about meeting business objectives without
considering whether these objectives could or do cause a conflict with ethical standards and
whether the set objectives have been met in line with the values and ethical principles of the
company. We call these systems bad trees.’ An example is the case of Jerome Kerviel, a French
trader who was at the center of the 2008 ‘Societe Generale’ trading and breach of trust incident.
Societe Generale is a major Paris, France based bank and financial services firm. Kerviel’s
practices have allegedly caused a 4.9 billion Euros loss to investors. In a statement he eluded that
Societe Generale’s senior management had never shown interest in his specific business methods,
but that they were very happy with the results of his work
53
.
It seems logical for firms to establish and use a two-dimensional performance
measurement and incentive structure that evaluates both, whether an employee has met his
business objectives (“what to achieve”) and whether he/she has achieved the objectives in line
with the pertinent values and ethical standards (“how to achieve”). This two dimensional
approach is of importance because ethical behavior will not be achieved by cutting or capping
incentives or bonuses at the upper end or because a positive correlation between performance and
reward is a crucial element of economic order.
Conceptualize this as two-dimensional matrix that evaluates on the vertical axis
performance along dimension related to fulfillment of the business objectives and on the
horizontal axis along dimensions related to values and behaviors. The critical motivation is to
26
systemically assure and safeguard that business objectives are met in line with the integrity
standards and that these in combination determine rewards. Such a model fosters and
institutionalizes an ongoing dialogue about the values-adequacy of business objectives. In other
words, it evaluates whether the agreed objectives are compatible with the ethical standards of a
company. The two dimensions described appear to be adequate in the governance of risks, in
reducing bonus excesses and to satisfy expectations of society with regards to the ethical
behavior of companies.
Research has shown that the effective implementation and application of such an incentive
system as part of an integrity and compliance program is the most important indicator of its
credibility, its effectiveness and of the capabilities of ethical oriented management. Furthermore
it bears potential for innovation and differentiation as it forces management and employees to
challenge common assumptions about the appropriateness of objectives and the way business is
being executed.
Training – A two-step concept focuses on awareness building and developing skills
Training is a critical element of an integrity and compliance program. Research in this
area has shown that employees and even more the management of a company need specific skills
to identify analyze and balance ethical, legal and economic considerations in order to be able to
male values based decisions. A training program should be based on a two-step model. The first
layer of training activities should seek to transmit information about integrity and compliance
concepts and specific knowledge. It should raise awareness about the ethical standards specify
and expected behavior. This can be done in face-to-face training sessions or through online
training instruments. Critical top management support is needed in order to establish active role
models. For example, senior management and the Board of Directors should participate in those
27
training sessions on a regular basis. Training should be specific to the target audiences based on
individual job related and company related risk assessments.
The second layer focuses on the development of integrity management and execution
skills. Managers should be trained in how to use integrity management practices as crucial tools
when making business decisions. This should then ultimately lead to ethically acceptable results.
The skill dimension becomes especially important in situations where the complexity of business
decisions, information asymmetry, business pressures, globalization effects, management across
diverse cultures, and the demand for sustainable business models is growing. The objective of
such skills training mainly focuses on the clarification of the major behavioral drivers and the
transfer of knowledge how to manage these. Conceptually skills trainings aims at developing the
competencies of managers to engrain ethics and values in the institutional framework of an
organization and hereby follows the concept of building organizations as collective moral
actors
54
. It also introduces practices and links these practices with the integrity and compliance
function of the organization.
Enforcing integrity standards
In order to enforce integrity standards an integrity and compliance program should entail
an integrated approach regarding decision-making processes, monitoring, whistle blowing, and
audits. Management should be firm in executing both, rewards “and’ punishment. Whenever
possible positive as well as negative examples should be communicated including their respective
effects on the bottom line. In reality this is not often the case, especially in firms that are afraid
that the reporting of negative effects could hurt investor confidence. In realty, our own field
research shows that the positive effects from corporate culture-change towards a high integrity
performance culture, far outweigh potential negative effects in the financial markets.
28
Decision-making – The institutionalization of integrity standards into decision-making processes
Another critical success factor for an effective integrity and compliance program is the
integration of integrity considerations in the decision-making processes throughout the value
chain; starting with research and development, then manufacturing, and then distribution
including marketing and sales. The processes that are important to consider are mostly generic
ones such as managing conflicts of interests, sustainable procurement, ethics in recruitment, and
career development. However, sometimes process modifications are necessary based on industry
characteristics. For example, the approval processes for certain promotional activities are
different in the pharmaceutical industry compared to other industries with less direct personal
health related impacts. The same applies to the processes that should enforce adherence with
human rights.
Monitoring and Reporting Assuring the effective implementation of an Integrity and
Compliance Program and transparent reporting
Enforcing responsible business practices needs meaningful and specific assurance and
monitoring processes. The responsibility for monitoring the implementation of an integrity
program rests with the integrity and compliance function; whereas the responsibility for
monitoring the employees whether they adhere to integrity standards and compliance criteria
rests with the respective functional or departmental management. The latter cannot be delegated
to the integrity and compliance department since it would otherwise disconnect responsibilities,
behaviors, and rewards, effectively rendering the rewards tool described earlier ineffective.
The monitoring of the implementation status can for example be done with a web-based
self-assessment tool that generates a data set about risk areas and potential gaps in the
implementation processes of certain standards. These data can also be used for benchmarking, to
29
identify best practice activities, which then can be replicated by others across the organization.
Another monitoring instrument is the use of an integrity survey that monitors the ethical climate
and the specific risk areas within an organization.
Further, reporting to internal and external stakeholders is an important task in order to
generate transparency and for organizational self-governance purposes. For this reason it can
make sense to build a direct reporting line from the Chief Integrity and Compliance Officer to the
CEO ‘and’ a member of the senior management or the board of directors. Nonetheless, regardless
how the structure will be built it is critical that the Chief Integrity and Compliance Officer has
sufficient decision-making power without being suppressed by speak-up problems in an
organization, especially to senior management.
For external communication purposes a company should use specific sections in the
general annual report. In addition, a specific annual integrity report, or a report on progress for
the UN Global Compact could further boost the effectiveness of integrity and compliance efforts,
especially with external stakeholders. The purpose of such reporting should be to provide
reasonably transparent insights into the most material topics, integrity management processes and
into their objectives and results. This reporting has the potential to create structural changes to
entire industries. For example, Apple now frequently reports during product launch events about
its environmental impact and almost all competitors followed this example.
Whistle-blowing – developing an internal complaints-handling process
Whereas many of the before mentioned processes are preventive in nature, an organization
also needs instruments to reveal, investigate and sanction integrity and compliance violations. It
is of utmost importance for the success of an integrity and compliance program to give sufficient
weight and focus to the elements that have the potential to influence, one of those is making
30
misconduct explicit. Employees should be able to report actual or suspected cases of misconduct
without repercussions. This processes is often referred to as ‘whistle blowing’. Such a process
must guarantee confidentiality, anonymity and protection from any form of retaliation.
In order to demonstrate credibility of the whistle-blowing process and to generate the
process needs to be made explicit and easy to use. Further, all employees should understand how
the process works including, how the incoming reports are being handled and how investigations
are conducted. Further, the number of reports that have been received and investigated as well as
the results and learning from the investigations should made public across the organization. We
suggest not making the whistle-blowing mechanisms a responsibility of the integrity function.
The reason is that the role of an Integrity and Compliance Officer should be much more that of a
trainer and advisor in cases of ethical doubts. If the prosecution function is combined with
training and advisory function, conflict of interests could arise and trust could be reduced, which
will make both essentially ineffective.
Audit – independent, internal assurance
The final activity required for an integrity and compliance program is an independent
internal check of the effectiveness of the internal control systems and the spotting of voids along
the processes. As with all audits the responsibility for all compliance audits should be with the
audit department as it is typically independent from the operational management. It also usually
reports directly to the Chairman of the Board of Directors instead of the CEO. The integrity and
compliance department would then be responsible for advising the audit function about potential
risk factors that need to be considered during the next audit cycle.
31
Conclusions
In this chapter we described a model for an integrity and compliance program that should
be easy to implement in a most organizations, regardless of size, industry, or location. The
proposed integrity and compliance program is conceptually very different form the traditional,
rules-based mitigation driven compliance programs that still dominate practice. Traditional
programs used to focus predominately on rule setting and monitoring. In contrast, the
fundamental idea of the described behavioral based program builds on a solid foundation of
values and then addresses the most important drivers of behaviors without letting traditional
elements such as monitoring or sanctioning out of sight. Without having such a behavioral and
holistic perspective, integrity and compliance management will be less effective in identifying
and preventing integrity risks
55
.
In addition, the proposed integrity and compliance program enables firms to react to
increasing levels of environmental dynamism caused by globalization effects and societal change
processes. The program proposed in this chapter enables managers to identify and develop
business opportunities based on business integrity capabilities. More and more firms take
advantage of these opportunities to, for example, reach consumers ‘at the base of the pyramid’ or
to provide additional value to consumers who are in return show greater loyalty. These additional
effects become a critical source of competitive advantage. Overall, the establishment of an
effective integrity and compliance program requires more than written standards. It requires an
integrity mindset that is ambitious and fully committed to ‘doing the right things’ while ‘doing
things right’.
32
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43 KPMG 2009, p. 6.
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Integrity & Compliance at Novartis.
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Strategy scholars have argued that capabilities can influence firm performance through a variety of means and mechanisms. However, the role of capabilities and their proposed contributions have been narrowly theorized and insufficiently tested. We contribute to resolving these issues by considering the conditions under which ordinary and dynamic capabilities contribute to higher relative firm performance. We do so by examining the positive and negative contributions of capabilities to relative firm performance as well as the effects of environmental dynamism and the degree of capability heterogeneity. We utilize measures of relative firm performance at both the process and firm level within a sample of Chilean firms, which due to a dynamic environment allows for a clearer link between the environment and the use of capabilities. We find that environmental dynamism negatively affects the contribution of ordinary capabilities and positively affects the contribution of dynamic capabilities to relative firm performance. Further, heterogeneity strengthens the contribution of dynamic capabilities to relative firm performance, but is less important for ordinary capabilities. Interestingly, we find support for the direct effects of capabilities to be stronger with a process-level performance measure, whereas the influences of environmental dynamism and heterogeneity are stronger with a firm-level measure. Copyright © 2010 John Wiley & Sons, Ltd.
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Die gegenwärtige Diskussion urn die Entschädigung von Zwangsarbeitern, die während des Herrschaft der Nationalsozialisten von deutschen Firmen ausgebeutet wurden, hat eine ganze Reihe von wichtigen wirtschaftsethischen Problemen aufgeworfen. So etwa die Frage nach der Berechtigung dieser Forderung im Hinblick auf die vergangene Zeit und im Hinblick auf die zum größten Teil nicht mehr lebenden individuellen Akteure der damals involvierten Unternehmen. Auf einer rein tugendethischen Basis sind solche Problemstellungen wohl kaum noch zu bearbeiten, da der Sache nach hier kollektive Akteure oder Korporationen und gerade nicht Individuen juristisch und moralisch verantwortlich gehalten werden. Mehr noch: Moralische Zurechnung kann hier überhaupt nur noch auf kollektive Akteure gelingen, und zwar nicht nur aus biologischen Gründen. Es ist die Kombination von Dauerhaftigkeit und Verfasstheit von Organisationen, die dazu gemeinsam die Voraussetzungen bilden. Erst eine solche Perspektive erlaubt es zu erkennen, dass dieser Vorgang für moderne Gesellschaften durchaus kein Novum bedeutet. Kinderarbeit, Entwicklungshilfe oder Menschenrechte, es existieren in der globalisierten Welt offensichtlich immer mehr moralische Fragen, für die den Unternehmen und gerade nicht den individuellen Akteuren der Wirtschaft Lösungskompetenz und damit verknüpft auch Verantwortung zugerechnet wird. Spitz formuliert: Die Zurechenbarkeit auf kollektive moralische Akteure wird mehr und mehr zur Bedingung der Möglichkeit moralischer Diskurse in modemen Gesellschaften.
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En esta obra, Douglass C. North, premio Nobel de Economía de 1993, expone un marco analítico para explicar las formas en que las instituciones y los cambios internos en ellas afectan a la economía.