Ethical Meltdown: Red Flags for Boards of Directors
By Jim Balassone
Corporate board members can take action to prevent or abate major ethical meltdowns
by being alert to red flags that show an organization is in trouble. Based on the work of
Marianne Jennings, in her book Seven Signs of Ethical Collapse, Katie Martin, partner at
Wilson Sonsini Goodrich & Rosati, Vince Vannelli, founder of KPG Ventures, Skip Battle,
chairman of Fair Isaac and Co., and I identified these eight areas that directors should be
diligent in monitoring.
These are warning signs that, in some cases, only the board can address, such as an out-of-
control CEO, or are characteristic of the board itself. Several are obstacles that prevent the
board members from effectively performing their fiduciary role.
Our list formed the basis of a panel discussion, "Red Flags of Ethical Collapse," that was
presented at the Silicon Valley Chapter of the National Association of Corporate Directors
May 17, 2012, meeting, which was co-sponsored by the Markkula Center for Applied Ethics
and Wilson Sonsini.
PowerPoint slides from the panel
Video of Katie Martin being interviewed by Jim Balassone
Red Flags for Boards of Directors
- A bigger-than-life CEO/Chair, like Richard Scrushy of HealthSouth, can spell
problems for a company. Hubris often clouds the rock-star CEO's judgment,
exemplified by this comment from a Silicon Valley CEO: "It is only illegal if you get
caught." There's an old adage in business: " The seeds of destruction are sown in
the best of times." Bravado and machismo reign when all is going well, and can
be taken to the extreme by an out-of-control, rock-star CEO. As a corollary, much
of the reputational damage to a company is done by the attempted cover-up of
inappropriate behavior by dysfunctional executives.
- Conflicts of interest either undermine integrity or the perception of integrity.
Directors should never waive company policy on conflicts, which should all be
managed by either eliminating or fully disclosing them as soon as they arise.
Transparency is a strong defense against problems such as excessive perks for
senior executives and/or Board members, family members profiting from company
relationships, and loans to the management team.
- Board members can become so highly specialized in their skills and experiences
that they create silos and become unable to see the big picture. This leaves analysis
and proposed actions to special committees with little overall oversight—creating
bureaucracy that leads to trouble—e.g. we thought that the "special-committee-for
special problems" was handling that, not our committee!
- Excessive pressure/extremely leveraged compensation (as instituted, for example,
at Countrywide Mortgage) can encourage rule bending and rule breaking. Such
pressures can't be modified by simply saying "…and we want you to abide by our
Code of Conduct as well!"
- Intense loyalty—institutional or to a leader(s) — distorts transparency and
integrity. In these circumstances, employees will defer to the leader even when
they know it's wrong or he/she is misguided. Such deference may also lead to the
rationalization that effectiveness in some areas atones for wrongdoing in others—
witness the controversy over Mark Hurd's termination at Hewlett-Packard or Joe
Paterno's at Penn State.
- Board members should not ignore or excuse the CEO's conduct in his or her
personal life. Both Harry Stonecipher and Phillip Condit lost their jobs as Boeing
CEO because of extramarital affairs with Boeing employees. Mark Hurd resigned
as CEO of HP after a sexual harassment probe was initiated into his behavior.
The company cleared him of the sexual harassment charge, but found other
improprieties related to his relationship with the employee in question. Recently,
Best Buy CEO Brian Dunn resigned after similar allegations. While unrelated
to the operations of the company, a CEO's personal misconduct does affect
the corporation's reputation. One of the panelists described it this way: "An
extramarital affair involves lying to a spouse, one of the most important people in
your life. What does that say about the character and truthfulness of the person
involved, and their willingness to lie to constituents?"
- Speaking truth-to-power is never easy, but creating an environment that encourages
everyone to be candid is the key to early discovery of problems in an organization.
Senior management's or the board's failure to speak or hear the hard truth creates
an atmosphere of fear and silence that can mask trouble until it's too late to take
corrective action. Overcoming the social stigma of appearing stupid to question
the appropriateness of a complex proposal takes a degree of courage and/or an
environment where questions and learning are valued.
- Board members should act like owners, not caretakers. Many board members
have no "skin in the game" and lack passion for and commitment to the company.
Corporate directors need to be leaders not shepherds. Board members' first
responsibility is to protect the interest of the shareholders of the organization. The
most efficient way to align this responsibility is to have all board members hold
stock in the company and experience increases and decreases in its value attributed
to the decisions they make directly, or those of management that they oversee.
James Balassone is executive-in-residence at the Markkula Center for Applied Ethics.
Katie Martin, of Wilson Sonsini, is a director of Nuance Communications, The Ronald
McDonald House at Stanford, WildAid, and the WSGR Foundation. Vince Vannelli, the
founder of early-stage venture fund KPG, serves on the boards of Clipsync, National
Payment Card Assoc., Solariat, TuneUp Media, Jildy, and Expect Labs. Skip Battle,
chairman of Fair, Isaac and Co., is a director of LinkedIn, Netflix, OpenTable, Expedia,
Sungevity, and Workday.