Developing a culture of effective and engaged followership can prevent financial sector scandals

Many employees at Wall Street banks were involved in transacting the problematic financial “products” that underlay the financial crisis in the US, such as negative amortisation and no-documentation housing loans for subprime borrowers, and certain related securitisations and credit derivatives. 

Why, then, is there scant evidence that such employees had effectively questioned these practices? Did they not feel any compunction? Or was their inner compass somehow stifled?

I raised these questions in Ethical Corporation in 2010, amidst the crisis’ aftershocks. 

I argued that Wall Street firms, generally speaking, could improve their risk management by fostering more open corporate cultures in which employees, including the “rank and file”, are given the freedom or even encouraged to voice ethics- or values-driven concerns regarding problematic business practices.

Questions cut crises

Such open cultures would enable employees to question issues more effectively at early stages, before those issues morph into catastrophic problems. By “effectively” I mean flagging issues for senior management as well as serving as a check on problematic practices which senior managers or other employees might have been condoning or even promoting.

Since that article, further scandals such as the “robo-signing” practices that led to “foreclosure-gate” have received wide press coverage.  Again, one must ask:  how could droves of employees at certain banks and mortgage servicers sign tens of thousands of affidavits that wrongly facilitated home foreclosures, with little evidence that they effectively questioned such practices?

Of course, corporate scandals are not limited to financial services companies – other industries have produced their fair share as well. One has only to think back to the accounting scandals that afflicted, rather fatally, both Worldcom (under Bernard Ebbers) and Enron. More recently, major drug companies have been found to engage in illegal promotions of unapproved uses of certain drugs.

This sample of corporate scandals suggests that the challenge of creating the conditions that allow employees to effectively question unethical or inappropriate business practices remains substantial among some US companies.

Corporate commitment

As I argued in 2010, “corporate leaders must by their daily words and deeds emphatically promote the new [open] culture, so that there is a credible case for employees to feel rewarded for raising in good faith any ethics issues or concerns.”

Such an approach would seem consistent with prevailing advice on corporate leadership. As Barbara Kellerman, an expert in such field, observes in her book, Followership (which looks at the leader-follower dynamic from the latter’s perspective): “Today’s corporate experts are urging today’s corporate leaders to get their followers to speak up. Superiors are being advised to provide a friendly environment, in which subordinates feel free to provide honest feedback.”

Certain corporate leaders do seem attuned to such feedback. For example, Kevin Sharer, Amgen’s chairman of the board (and former CEO), recently explained – in an interview published in McKinsey Quarterly – why attentive listening to subordinates and other stakeholders is a critical skill for leaders and organisations, and why teaching and modelling this behaviour by leaders is important.

Nevertheless, being open to honest feedback from subordinates may not come easily to some CEOs or other corporate leaders. Such openness may be perceived by a corporate leader as an admission that he is not as smart, knowledgeable or in control as he thinks he ought to be.

Moreover, instead of seeing such open culture as a means of tapping into employees’ collective wisdom in innovating products or ferreting out business risks, such a corporate leader may perceive willingness to solicit feedback as ceding power to others in the organisation.

Value-based leadership?

Even the idea of “value-based leadership”, often touted as a way to instil an ethical corporate culture (including the freedom to “speak truth to power”), needs to be approached with a discerning eye in its practical application.

As James Hoopes warns in his book Corporate Dreams, which is about the struggles between employee rights and management power, “many gurus … made values into tools rather than goals, into means rather than ends …[and] taught managers to try to change followers’ values in order to manipulate them”.

In the absence of a genuine desire or ability on the part of some corporate leaders to listen to honest feedback, even if such leaders overtly espouse values or ethics, they may risk missing valuable or even critical input into their decision-making, resulting in poorer quality of decisions affecting adversely their companies’ bottom line or reputation.

How, then, can corporate leaders’ commitment to stay open to honest, good faith feedback from their followers be enhanced more widely? The answer may lie at least in part in institutional investors’ involvement in corporate governance reforms.

Open governance reforms culture

As Benjamin Heineman and Stephen Davis point out in their paper Institutional Investors: The Next Frontier in Corporate Governance: “Over the last 20 years, institutional investors have owned an increasing share of public equity markets – more than 70% of the largest 1,000 companies in the United States in 2009, for example.” Therefore, the ability of institutional investors to influence corporate governance at their investee companies is potentially very substantial.

Institutional investors – at least the larger, more sophisticated ones – have had a long-standing interest in improving corporate governance at their investee companies, as part of their initiative to incorporate ESG (environmental, social and governance) factors into their investment decisions and behaviour.

As Mercer (US) stated in a report to CalPERS (the California Public Employees’ Retirement System) in 2011: “It is fair to say that most investors … put some value in the assessment of governance in preventing scandals from breaking within the portfolio. Scandals relating to fraud (Enron, Madoff etc) show that breaches of ethical norms can be intertwined with unforeseen investment risk.”

There is governmental support for institutional investors’ involvement in investee corporate governance. For example, under the US Dodd-Frank Act, enacted in 2010, shareholders are granted certain “say-on-pay” rights as to executive compensation. Citigroup shareholders recently used such rights to indicate their rejection of a proposed pay package for its CEO.

The United Kingdom has adopted the Stewardship Code, which states in its preface that it “aims to enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities. Engagement includes pursuing purposeful dialogue on strategy, performance and the management of risk.”

The UN’s Principles for Responsible Investment (UNPRI), are meant to encourage signatories thereto to incorporate ESG considerations into their investment analysis and behaviour.

Get beyond the traditional

A survey of studies and reports in the responsible investment space in the US suggests that governance reform efforts by institutional investors have revolved around relatively “traditional” ideas. These include installing more independent directors on boards, separating the CEO and board chairman roles, increasing shareholders’ proxy access, supporting majority (as opposed to plurality) voting for directors, giving input on management compensation, and the like.

While all of these efforts are important, currently there appears to be a relative absence of initiatives aimed squarely at the open culture model advanced here, which seeks to mate the burgeoning field of followership with sound risk management in the form of a genuinely open corporate culture.

This approach would treat employees, including the rank and file among them, as true stakeholders and empower them to constructively engage with the mission of their organisation. Such engagement should include serving as a source of “effective questioning” of inappropriate or unethical business practices.

Several factors may underlie the absence of attention to the open culture-oriented approach to governance.

First, conventional views of stakeholders tend not to see the interests of shareholders, on the one hand, and those of employees, on the other, as being fully aligned. After all, at first blush, the more corporate resources are allocated toward employee compensation and benefits, the less there is left for shareholders.

Second, employees have traditionally been seen as a management issue, so shareholders may feel reluctant to be seen as intruding into management’s “turf”.

Finally, the followership field is still relatively new and evolving. For example, Barbara Kellerman’s book came out in 2008.

Nevertheless, none of these factors should impede institutional investors’ support for open corporate cultures. On the contrary, upon further analysis, these factors point to strong reasons in favour of such support.

Wilfred Chow is a US-based lawyer and corporate governance researcher and writer. He previously served as a managing director and associate general counsel at a leading financial services firm in the US.

This is the first in a series of three op-eds from Chow examining the benefits of open corporate cultures in the financial sector. 

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