Shades of Gray - corporate codes of ethics

Jerry G. Kreuze

Universal codes of ethics cannot be overlaid in every sector of the

world, or in every market. Internal auditors -- especially those who
work in multinational organizations -- must understand the mix of
ethical behaviors and how they impact corporate codes of ethics.

Well-developed corporate codes of ethics help organizations foster

ethical environments, deter unethical behavior and cope with problems
and ethical dilemmas. The codes establish the ground rules by which
the organization operates and evaluates.

By its very nature, however, the zone of business ethics can be

amorphous. It can be pervaded by many shades of gray, even in
environments that are quite similar. When the environments are
clearly diverse, boilerplate codes of ethics will not be relevant or
effective.

Complex cultural, individual, and market-based forces influence ethical

behavior in different parts of the world. For example, the ethical
demands placed on companies operating in intensively competitive,
ethically hostile environments are significantly different from those of
companies operating in regulated, highly stable environments.

As more companies engage in international trade and expand their

operations across national boundaries, understanding the factors that
drive ethical decision-making becomes increasingly important. Internal
auditors should be aware of all the elements that impact ethical
behavior and how they interact.

THE IMPACT OF CULTURE AND COMPETITION

Two key forces -- the culture and the competitive intensity of the
market -- have great impact on ethical behavior. Although these
dynamic components must ultimately be considered jointly, each must
also be understood separately.

CULTURAL FACTORS People from different cultures generally do not

have the same values. Because values are linked to ethical beliefs,
codes of ethics must consider these divergent value systems.
Cultural ethical issues were addressed to some extent in the U.S.
Foreign Corrupt Practices Act of 1977. This legislation makes it a crime
for U.S. based multinationals to make "sensitive payments," or bribes,
to officials of foreign governments. The act implies that U.S. ethical
standards should apply to business activities both inside and outside
its boundaries, thereby establishing a clear example of moral
absolutism, where one universally acceptable set of moral views and
behavior is defined. Additionally, the Organisation for Economic Co-
operation and Development's Convention on Combating Bribery of
Foreign Public Officials in International Business Transactions, obliges
signatories to adopt national legislation that makes it a crime to bribe
foreign public officials.

Yet, societies can vary along several cultural dimensions; and ethical
behavior is not absolute in all nations. If issues are not clearly
immoral, such as murder, then cultural relativism argues that no one
culture's ethical standards are any more or less moral than those of
other cultures. Culture-based codes of ethics must consider each
country's views with regard to moral absolutism. Internal auditors
must not only be aware of these differences; they should also be
cognizant that in some countries a universally imposed code of ethics
could be in opposition to deeply held beliefs.

G. Hofstede, author of Culture's Consequences: International

Differences in Work-related Values, suggests that societies differ along
four cultural dimensions: individualism/collectivism, power,
masculinity/femininity, and uncertainty avoidance:

* INDIVIDUALISM/COLLECTIVISM. In societies where individuals are

primarily concerned with their own interests and the interests of their
immediate families, individualism is emphasized. Collectivism, on the
other hand, views individuals as members of a group, and group
norms supplant individual morals.

In the United States, for example, the tendency is toward

individualism, and many codes emphasize individual conduct issues.
Those codes should be reevaluated, however, when a corporation
operates in countries such as India that emphasize collectivism. Codes
that emphasize policies for the "good of the company" may not be
effective in countries that stress individualism, but they are well-
positioned for collectivism cultures.

* POWER. Societies vary to the extent that they accept inequality in

power and consider inequality to be normal. Great disparity in pay and
benefits among worker groups may create incentives for the less
advantaged to cheat on hours worked and to borrow corporate assets.
Large executive compensation and benefit packages tend to create
significant hostility and resentment in some countries.

Conversely, policies calling for significant equities among workers may

also create conflict. The idea that less powerful individuals in society
should regard inequity as normal is widely accepted in some societies.

* MASCULINE/FEMININE. Masculinity-based cultures accept

assertiveness, competitiveness, and the accumulation of material
wealth. In feminine societies, relationships are perceived to be of great
importance; and the role of each sex is seen as essentially equal.
Cultures favoring femininity would advocate equal pay for equal work
and favor benefits for working parents, for example.

* AVOIDING UNCERTAINTY. The level of frustration brought on by

unstructured, unpredictable situations varies from one environment to
another. Some societies, such as Greece, tend to be intolerant of
personal risk, whereas citizens in the United States generally accept
greater uncertainty and personal risk. Codes of ethics that are very
detailed and attempt to mandate specific behavior may cause
frustration for individuals who thrive in unstructured, unpredictable
situations, but they would be well-received in societies intolerant of
personal risk.

Internal auditors must be fully aware of the dynamics culture creates

in corporations and in their codes of ethics. Auditors' assessments and
recommendations will be far more meaningful if they reflect and
incorporate these understandings.

PERFECT VS. IMPERFECT MARKETS Market-based factors can create

powerful incentives and impediments for corporations. In perfect
markets there are no significant barriers to entry, meaning there are
no significant capital expenditures or government regulations. In such
markets where numerous businesses compete vigorously with each
other for customers, companies may be inclined to violate even
minimally imposed legal standards. These companies operate
according to a survival mentality, as customers typically hold no
loyalty to a particular business and product, and the company is
operating with razor-thin profit margins.

Perfect markets require firms to act smartly, but they do not induce
them to act ethically. In fact, perfect markets frequently are imperfect
in their enforcement of business morality. Moreover, anonymity
inherent in these markets further fosters unethical behavior.

In competitive markets, codes of ethics must be closely monitored. In

the short run, the internal auditor should determine whether employee
behavior is at the level minimally required by laws and regulations. In
the long run, a commitment by management to a high ethical standing
must be effectively transmitted and modeled to employees.

Imperfect markets dominated by large companies constitute a sizable

segment of today's organized business activity. These oligopolistic
market structures are created by numerous factors, including
technological innovations, information asymmetry, large capital
requirements, and government regulations. Reputation, industry
stature, repeat business, and-customer loyalty are key elements.

In theory, organizations in imperfect markets do not face the severe

price constraints of intensively competitive markets and may be able
to generate above-average profits. Consequently, these companies
tend to behave more ethically than companies operating in intensively
competitive environments. Their large-scale operations require
collective action, with each individual contributing little in relationship
to the whole. As a result, collective ethical morals replace individual
beliefs, or, at least, they tend to influence individual beliefs to a great
extent.

In such environments, corporate codes of ethics are usually more

effective and controlled. Internal auditors should respond accordingly
by helping to develop effective codes of ethics and ensuring employee
awareness and adherence to those guidelines for behavior.

MELDING CULTURAL AND MARKET-BASED FACTORS

Unethical business conduct occurs in large and small firms, in perfect

and imperfect markets, and in good and bad times. Thus, ethical
behavior can be linked to a mix of cultural and market-based factors.
The following framework can be used to assess the effectiveness and
appropriateness of the corporate code of conduct. Such assessments
can be critical as auditors determine the extent of substantive tests of
the records and form an opinion of the reliability of the financial
system. The framework is divided into four sectors based on
competitive/industry factors.

SECTOR A:
ETHICALLY HOSTILE ENVIRONMENTS

Although ethically hostile environments could occur anywhere, most of

them likely lie in emerging regions where a common ethical framework
and legal constraints on corporate behavior might be lacking. Many
corporations in Sector A environments are strictly profit maximizers.
Individual ethics, although present, do not make a significant impact
on the culture.

The environment creates competitiveness, rather than cooperation,

among individuals. Culture-based ethics can help neutralize the
situation in the long-term. On the other hand, strong culture-based
ethics can complement corporate codes, especially when the codes are
strong. Nonetheless, behavioral changes may be slow and require
constant monitoring.

In Sector A environments, initial emphasis should be placed on

compliance with minimum legal requirements. Over the long-term,
corporate codes can constrain corporate behavior to create an
environment that fosters ethical behavior beyond the legal minimums.
In this environment, corporate codes of ethics must be fully
communicated to employees and be consistent with the ethical aspects
of culture-based ethical standards. Behavior must be continually
monitored and compared to the code of ethics. Sanctions for unethical
behavior must be strictly enforced to encourage adherence to the code
of ethics.

SECTOR B: HIGHLY COMPETITIVE AND ENTREPRENEURIAL

ENVIRONMENTS

In highly competitive and entrepreneurial environments, such as in

startup companies and the e-commerce industry, a sense of
individualism is created. Individual ethics, and the culture-based ethics
creating them, dominate.

Individuals in Sector B environments may have a closer alliance to

their professional organizations than to the company. Because
professional organizations may, therefore, have more impact than
corporate codes on ethical behavior, management will likely want to
encourage employee participation in professional organizations with
strong codes of ethics. The professional organizations become the
police force, with corporate codes filling in the gaps and shortcomings
of the professional codes of ethics.
Culture-based ethics remain important, because they are ingrained in
individuals, singularly and collectively. These ethics serve as a
foundation for professional and corporate ethics. If the codes of ethics
of professional organizations are to have credence, however, they
must be consistent with the culture-based ethics of the vast majority
of its members -- and so must corporate codes of ethics.

SECTOR C: REGULATED OR HIGHLY STABLE AND MATURE

ENVIRONMENTS

Regulated or highly stable and mature environments, such as utilities,

mining, and railroads, may be the most ethical. The maturity of the
industry suggests that culture-based ethics already are consistent with
corporate policies. Also, the typical stability of employment in Sector C
companies promotes more loyalty to the company, rather than to
professional organizations.

Effective codes of ethics are perhaps most important in Sector C,

however. Older, well-established companies should already be in
compliance with culture-based ethics, but as demographics change,
the culture-based ethics become fluid. Corporate codes of ethics must
adjust to these shifts where necessary.

Professional and corporate codes of ethics continue to be important

deterrents to unethical behavior in Sector C environments. Corporate
codes are an effective way of maintaining order, and they should
effectively complement professional, culture-based, and individual
codes of ethics.

SECTOR D: HIGH GROWTH ECONOMIC ACTIVITY

Dramatic, rapid changes cause stress on culture-based ethics,

frequently modifying these ethics to conform to the new order.
Individuals in Sector D corporations often experience confusion and
inconsistencies, weakening the impact of individual, professional, and
organizational codes of ethics. The environment becomes the primary
focus, supplanting professional loyalties.

Effective, fully communicated corporate codes can be an important

element in adding stability and consistency. Modifications in these
codes maybe required as the industry evolves and matures. In this
environment, internal auditors must primarily rely on the corporate
code of ethics to drive ethical behavior.
GUIDING CORPORATE BEHAVIOR

Effective codes of ethics are vital to organizations on many levels. At a

practical level, they can also dramatically affect internal audit practice.
In situations where unethical behavior is suspected, the lack of a code
of ethics multiplies the internal auditors' required tests and
significantly lessens the validity of any assurances rendered.

In their evaluations, internal auditors must acknowledge, assess, and

consider jointly all the elements that act as powerful incentives and
impediments in guiding corporate ethical behavior. Auditors must
differentiate among the shades of gray and recognize that "one size
fits all" cannot be applied to corporate codes of ethics.

JERRY G. KREUZE, PhD, MBA, CPA, is professor of accounting at

Western Michigan University in Kalamazoo.

ZAHIDA LUQMANI, MBA, is an instructor of marketing at Western

Michigan University.

MUSHTAQ LUQMANI, PhD, MBA, is professor of marketing at Western

Michigan University.

[Table omitted]

Assessing an Organization's Ethical Climate

As a creation of a society, every organization -- whether economic or

political, private or public -- has primary, overarching responsibilities
to that society to be obedient, benevolent, and accountable. The
organization uses various legal forms, structures, strategies, and
procedures to ensure that it complies with society's legal and
regulatory rules; satisfies the generally accepted business norms,
ethical precepts, and social expectations of society; provides overall
benefit to society and enhances the interests of the specific
stakeholders in both the short- and long-term; and reports fully and
truthfully to its owners, regulators, other stakeholders, and general
public to ensure accountability for its decisions, actions, conduct, and
performance.

At a minimum, the internal audit activity should periodically assess the

state of the ethical climate of the organization and the effectiveness of
its strategies, tactics, communications, and other processes in
achieving the desired level of legal and ethical compliance. Internal
auditors should evaluate the effectiveness of the following features of
an enhanced, highly effective ethical culture:

* Formal code of conduct, which is clear and understandable, and

related statements, policies (including procedures covering fraud and
corruption), and other expressions of aspiration.

* Frequent communications and demonstrations of expected ethical

attitudes and behavior by the influential leaders of the organization.

* Explicit strategies to support and enhance the ethical culture with

regular programs to update and renew the organization's commitment
to an ethical culture.

* Several easily accessible ways for people to confidentially report

alleged violations of the code, policies, and other acts of misconduct.

* Regular declarations by employees, suppliers, and customers that

they are aware of the requirements for ethical behavior in transacting
the organization's affairs.

* Clear delegation of responsibilities to ensure that ethical

consequences are evaluated, confidential counseling is provided,
allegations of misconduct are investigated, and case findings are
properly reported.

* Easy access to learning opportunities to enable all employees to be

ethics advocates.

* Positive personnel practices that encourage every employee to

contribute to the ethical climate of the organization.

* Regular surveys of employees, suppliers, and customers to

determine the state of the ethical culture of the organization.

* Regular reviews of the formal and informal processes within the

organization that could potentially create pressures and biases that
would undermine the ethical culture.

* Regular reference and background checks as part of the hiring

procedures, including integrity tests, drug screening, and similar
measures.
Excerpted from Practice Advisory 2130-1: Role of the Internal Audit
Activity and Internal Auditor in the Ethical Culture of an Organization,
an Interpretation of Standard 2130 from the Standards for the
Professional Practice of Internal Auditing.

COPYRIGHT 2001 Institute of Internal Auditors, Inc.

COPYRIGHT 2002 Gale Group