TOMORROW, the Financial Reporting Council will announce the first part of its new code of conduct for corporate governance. It is a welcome step towards ensuring that businesses behave in a responsible way, but more is needed.
It has been striking in recent times that the public and policymakers have blamed business’s failures on ethical lapses. Accounting scandals at Enron and WorldCom, financial crises partly built on questionable financial behaviour and bumper bank bonuses have all been criticised as not just a corporate failures, but moral ones. Bodies like the FRC have a role in encouraging ethical behaviour in business, but other stakeholders do too, not least professional bodies.
But before we look at how they can encourage ethical behaviour, it’s helpful to look at the basics. Ethics in a business context have been defined by Paul Makosz, a former consultant on ethical issues to the World Bank and blue-chip North American corporations, as “principles or norms of behaviour regarded as desirable by the majority of society”. Even if we accept this, it doesn’t help a lot. The second you go any further and actually implement this concept of ethics in real life, everything gets rather complicated.
For a start, we’re immediately confronted with a problem: how do we enforce those ethics? Broadly speaking, there are two approaches to enforcing ethics in business: a rules-based and a principles-based approach.
In a rules-based system, everyone – the regulated, the regulator, and the public – knows exactly what is permitted, and all stakeholders have to do is to follow the rules. Historically-speaking, the rules-based approach has been the most popular. When things have “gone wrong”, the usual response of an authority has been to issue new rules or regulations.
But this system has two problems. Firstly, new rules create new compliance costs for business, which means companies must work harder to increase revenues to cover those costs. Chasing the extra revenue can make companies more willing to bend rules. And that is the second problem: rules can be bent. Rules define what is and isn’t allowed, but there are always plenty of things that are allowed because they aren’t covered by the rules. Worse, “acting within the rules” can allow companies to justify what could otherwise be considered unethical behaviour. Acting within the letter, but not the spirit of the rules can lead to trouble.
Take, for example, the use of Repo 105 accounting by Lehman Brothers. The investment bank was able to make assets disappear off its balance sheet, simply by picking and choosing which legal jurisdictions it got its legal opinions and accounting standards from. But Lehman never broke the rules. ACCA was one of the first to note that rules-based corporate governance frameworks were an accident waiting to happen. Every bank that failed in the crisis complied with corporate governance requirements.
Anthony Belchambers, chief executive of the Futures and Options Association, argues that “ethics has been replaced by observance of rules. People have outsourced their sense of behavioural responsibility to compliance with external rules”. This is something that the Walker Review noted too, but Walker’s proposed solution is more regulations for banks to comply with.
The alternatives to rules are principles. Importantly, while you can dodge a rule, you can’t dodge a principle. Again, though, there are problems. While rules make sure you know exactly what is and what isn’t allowed, principles leave grey areas. Often, only hindsight clarifies whether something was right or wrong.
Then there’s the fact that principles only work well in a principled environment. In an environment where the prevailing culture is to comply with the letter but not the spirit of the law, and even then only when someone is looking, principles may be a normative aim too far. Besides, according to whose principles should businesses conform?
Expectations of ethical conduct in business must acknowledge that businesses exist to make a profit, and that they have to behave in a way that maximises value for their shareholders. In that case, you could argue that businesses should be allowed to operate in a way that places pure business interest above the public interest. According to Makosz, that would make such behaviour unethical. Social usefulness is paramount. Businesses are a part of society, and cannot be allowed to behave in ways that undermine it.
The International Federation of Accountants (IFAC) certainly takes this view and places the public interest in a position of utmost importance in its code of conduct: “A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest”. Businesses must therefore behave in a way that would be considered ethical by society at large. But this returns us to our earlier conundrum: a rules-based or principles-based approach?
As strong supporters of International Financial Reporting Standards (IFRS), we at ACCA are naturally inclined to support a principles-based approach; principles cannot be avoided, as rules can be.
It is encouraging that the Financial Reporting Council’s proposed UK Corporate Governance Code places an emphasis on principles rather than rules. However, there is still the issue that principles work best in a principled environment. Environments are shaped by those that inhabit them. It is the principles of CEOs, CFOs, and other finance professionals that will decide whether a principled approach works or not.
You can’t force people to be ethical, but you can certainly help them. This is why, in 2007, at ACCA we overhauled our syllabuses to place ethics and professionalism at the heart of our qualification. It is up to us and other accountancy bodies to create principled accountants – the CEOs and CFOs of tomorrow – who will place ethical behaviour and the public interest at the top of their priorities.
Ethics and professionalism are assessed in 11 of the 16 ACCA qualification syllabuses. We have an online ethics module – the first of its kind – which takes students and members through various ethical dilemmas to raise their awareness of ethical values, and aims to make it easier for our students and members to exercise good judgement in the future.
Any ACCA affiliate wanting to become an ACCA member must have completed this module. We are committed to training not just people that are good accountants, but accountants who are good people. With principled accountants, a principles-based approach to the enforcement of ethical behaviour can work.
Paul Moxey is head of corporate governance and risk management at ACCA, the Association of Chartered Certified Accountants