Markkula Center of Applied Ethics

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

  1. 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.
  2. 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.
  3. 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!
  4. 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!"
  5. 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.
  6. 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?"
  7. 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.
  8. 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.