The five-minute management idea: use integrity to boost profits

22 March 2018 -

Integrity workA weekly shot of new thinking for business leaders: heightened integrity improves workplace performance

Guest blogger Alan Barlow

Capitalism is in crisis. There is a growing disconnect between business and society. While business is driven by profitability, society wants business to act with integrity. So is it possible to have both at the same time? The answer, in my view, is: yes.

There are six reasons why we must make a case for a “pro-integrity” approach to business today:

  1. Endemic corruption
  2. Inadequacy of compliance
  3. Insufficiency of good governance
  4. Irrelevance of corporate social responsibility
  5. Ethics being disconnected from organisational realities
  6. Heightened integrity delivers for business and for society (see table below)

Let’s look at each factor in turn.

Endemic corruption. The cost of corruption to society is enormous. The World Economic Forum calculates the cost of corruption in 2011 to be more than five per cent of global GDP ($2.6trn). In addition, it’s been estimated that, on average, corruption increases the cost of doing business by up to 10%.

Inadequacy of compliance. The aftermath of the 2007 financial crisis demonstrated that many of the otherwise prestigious banks were corrupted in knowingly mis-selling mortgage-backed securities, interest rate manipulation, aggressive tax avoidance and money laundering. Although there were no reported severe statutory compliance issues in the run-up to 2007, subsequently a total of £252bn ‘conduct costs’ have been racked up by the world’s 20 biggest banks in the five years to 2016. These included the Bank of America, Barclays Bank, Citibank, Deutsche Bank, Goldman Sachs, JP Morgan and Morgan Stanley.

Insufficiency of good governance. In 2014, Hermes Fund Managers examined the role of governance in a company in terms of its impact to increase financial performance. Based on an analysis of 1,600 companies in the MSCI World Index, it found that it was not good governance that leads to outperformance, but poor governance that leads to underperformance. The governance factors analysed were board independence, poison pills, remuneration, independent directors, combined CEO/chair role, risk management, business ethics and proxy voting.

Irrelevance of corporate social responsibility. Corporate social responsibility (CSR) is increasingly seen to be a ‘nice to have’. Alex Edmans’ comprehensive review of CSR and corporate US stock market performance found a zero or negative effect of high CSR score and stock returns. Research has shown that companies with the highest CSR scores also make the greatest efforts to avoid tax. According to The Economist, this apparent contradiction can be explained by the fact that the management responsible for tax affairs and for CSR operate in separate corporate silos.

Ethics: little connection with organisational realities. The discussion of ethics has often tended towards the general and philosophical, detached from organisational realities. It is mainly argued in terms of ‘doing the right thing’ with little evaluation or quantification of how it could at the same time generate greater business performance. But having a code of ethics or having the power of distinguishing between right and wrong is by itself insufficient.

Heightened integrity delivers. Heightened integrity, by contrast, is about leaders, management and staff driving an organisation’s business performance through how they behave.

Heightened integrity delivers superior profitability

Ethics, governance, heightened integrity and profitability

Source: Barlow, 2018

Heightened integrity can be defined as follows:

  • Visibility in what leaders and management and staff say, what they do, and how they behave.
  • Positively impacting the interaction between management and staff and their behaviour.
  • Leaders, management and staff taking a proactive stance as to what is acceptable and unacceptable behaviour.
  • It being a prerequisite of how CEOs go about leading and managing their corporation, not an afterthought for management.
  • It being a core business process. That is, the modus operandi of management and staff.

When these concepts are fully operational, they provide the required foundation for both management and staff to deliver exceptional overall workplace quality of heightened integrity and subsequent superior business performance.

Alex Edmans conducted a rigorous assessment of this relationship in terms of the stock value of companies listed in the Great Place to Work Institute’s annual survey, ‘100 Best Companies to Work for in America’. He found a direct causal link between a firm’s financial performance and overall workplace quality. Measured against their peers, from 1984 through 2011 this generated 2.3 to 3.8% higher stock return per year. Over a period of ten years, this equates to a better stock differential return than from peers of 23 to 38%.

When companies operate with heightened integrity, the benefits to society include stronger governance, a more fulfilled workforce, reduced mismanagement, reduced maladministration, reduced corruption, greater market efficiency and improved allocation of resources for society. Business thus becomes a force for good in society.

Alan Barlow is a former partner at PriceWaterhouseCoopers, a former director of a FTSE 100/NYSE-listed energy group, former CEO of a chemical engineering multinational, and the author of Profiting from Integrity: How CEOs Can Deliver Superior Profitability and Be Relevant to Society (Routledge, 2018).

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