Monday, June 26, 2017 8:32 AM /PwC
The job of a chief executive officer at a large publicly held company may seem to be quite comfortable — high pay, excellent benefits, elevated social status, and access to private jets. But the comfortable perch is increasingly becoming a hot seat, especially when CEOs and their employees cross red lines.
As this year’s CEO Success study shows, boards of directors, institutional investors, governments, and the media are holding chief executives to a far higher level of accountability for corporate fraud and ethical lapses than they did in the past. Over the last several years, CEOs have often garnered headlines for all the wrong reasons: for misleading regulators and investors; for cutting corners; and for failing to detect, correct, or prevent unethical or illegal conduct in their organization. Some high-profile cases, involving some of the world’s largest corporations, have featured oil companies bribing government officials and banks defrauding customers.
To be sure, the number of CEOs who are forced from office for ethical lapses remains quite small: There were only 18 such cases at the world’s 2,500 largest public companies in 2016. But firings for ethical lapses have been rising as a percentage of all CEO successions. (We define dismissals for ethical lapses as the removal of the CEO as the result of a scandal or improper conduct by the CEO or other employees; examples include fraud, bribery, insider trading, environmental disasters, inflated resumes, and sexual indiscretions. See “Methodology,” below.)
Globally, dismissals for ethical lapses rose from 3.9 percent of all successions in 2007–11 to 5.3 percent in 2012–16, a 36 percent increase. The increase was more dramatic in North America and Western Europe. In our sample of successions at the largest companies there (those in the top quartile by market capitalization globally), dismissals for ethical lapses rose from 4.6 percent of all successions in 2007–11 to 7.8 percent in 2012–16, a 68 percent increase.
Our data cannot show — and perhaps no data could — whether there’s more wrongdoing at large corporations today than in the past. However, we doubt that’s the case, based on our own experience working with hundreds of companies over many years. In fact, our data shows that companies are continuing to improve both their processes for choosing and replacing CEOs and their leadership governance practices — especially in developed countries. But over the last 15 years, the environment and context in which companies operate has changed dramatically as a result of five trends.
First, the public has become more suspicious, more critical, and less forgiving of corporate misbehavior. Second, governance and regulation in many countries has become both more proactive and more punitive. Third, more companies are pursuing growth in emerging markets where ethical risks are heightened, and relying on extended global supply chains that increase counterparty risks. Fourth, the rise of digital communications has exposed companies and the executives who oversee them to more risk than ever before. Finally, the 24/7 news cycle and the proliferation of media in the 21st century publicizes and amplifies negative information in real time.
Add it all up, and you get greater scrutiny of CEO behavior, a greater desire for swift justice and action, and a smaller margin of error for all parties involved. But there’s good news for CEOs, their leadership teams, and their boards.
Organizations can protect themselves by making sure that their controls and compliance programs are truly world-class, and — even more important — that their corporate culture sends and reinforces clear, well-understood messages about ethical conduct.
Room for Improvement
Globally, this year’s study shows that although there is still room for improvement, boards continue to get better at planning smooth successions and bolstering corporate governance. Over the last decade, the number of forced turnovers has dropped significantly.
From 2007 to 2011, forced turnovers accounted for 31.1 percent of total turnovers at the 2,500 largest companies, whereas from 2012 to 2016 the share of forced turnovers fell sharply, to 20.3 percent. Our data also shows that the concentration of power in a single person is declining: The share of incoming CEOs who also serve as chair of the board at the world’s 2,500 biggest companies has been dwindling steadily, from 48 percent in 2002 to 10 percent in 2016.
However, dismissals for ethical lapses increased significantly over the last five years — on a global basis and in each of the three major regions we analyze: the U.S. and Canada; Western Europe; and Brazil, Russia, India, and China (the BRIC countries). The share of all successions attributable to ethical lapses rose sharply in the U.S. and Canada (from 1.6 percent of all successions in 2007–11 to 3.3 percent in 2012–16), in Western Europe (from 4.2 percent to 5.9 percent), and in the BRIC countries (from 3.6 percent to 8.8 percent; ).
We believe that the rising numbers of dismissals for ethical lapses in the U.S. and Canada and Western Europe stem from the fact that the changes in the business environment we’ve cited — in public opinion, governance and regulation, operating risk, digital communications, and media attention — are most pronounced in those regions. The fact that dismissals for ethical lapses were even higher at companies in the top quartile by market capitalization in these regions supports that hypothesis, because the largest companies are the ones most affected by these changes and are subject to the greatest scrutiny ().
The higher rate of dismissals for ethical lapses in companies in the BRIC countries reflects these changes as well, but in an amplified way, given the historical pervasiveness of corruption in the countries in which these companies operate. Among the BRIC countries, for example, Transparency International’s Corruption Perceptions Index 2016 ranked Brazil, India, and China in 79th place (tied) out of 176 countries analyzed, and Russia was in 131st place.
A Sea Change in Accountability
The financial penalties that companies face have rocketed — in some recent cases, into the tens of billions of dollars. And media attention, from online outlets, cable television channels, and the relentless glare of social media, is omnipresent. We believe that the five tectonic shifts identified above have forged this new era of CEO accountability.
Confidence and trust in large corporations and CEOs have been declining for decades. But the decline has accelerated since the financial crisis of 2007–08, the Great Recession, and the slow recovery that ensued. Corporations and executives received government bailouts, while seeming to suffer little in the aftermath. Although many companies paid large fines and settlements, few were charged criminally, even in instances where unethical and illegal activity was widespread and well documented.
Media attention has also focused more and more on corporate tax avoidance and the offshoring of jobs, as well as record-high rates of executive compensation and rising income inequality in general. Those are the areas that, although not illegal, do not promote goodwill.
The upshot: Only 37 percent of people consider CEOs credible today, according to the — an all-time low for the 17-year-old survey, and down 12 percent from just last year. According to a long-running Gallup poll, whereas 34 percent of citizens surveyed in the U.S. in 1975 said they had “a great deal” or “a lot” of confidence in big business, only 18 percent said so in 2016.
Heightened public criticism and skepticism of executives and corporations have translated directly into regulatory and legislative action. Over the last 20 years, new laws — generally passed after scandals or market crashes — have ratcheted up scrutiny of CEOs and corporations and mandated much more formal and extensive compliance practices.
In the U.S., the Sarbanes-Oxley Act of 2002, enacted in the wake of the Enron and WorldCom scandals, fundamentally changed the nature of corporate regulation, and similar measures were enacted in many other countries.
The Dodd-Frank Act of 2010, which imposed new regulations and standards, included further measures to detect, discourage, and punish corporate wrongdoing. To keep on the right side of such laws, companies in the U.S. and many other countries have moved to a zero-tolerance approach toward bad behavior in the C-suite.
One effect of these measures has been to shift the focus of accountability from companies to individuals. Indeed, prison sentences for corporate malfeasance have been increasing. Between 1996 and 2011, the mean fraud sentence for individuals in U.S. federal courts nearly doubled — from just over one year to almost two years.
During the same period, the mean sentence for all federal crimes dropped from 50 to 43 months. (It’s worth noting that a debate is currently under way in the U.S. about whether business regulation has become overly stringent, potentially signaling an inflection point in the trend toward increased corporate oversight.)
The threats that companies face in the normal course of business have multiplied in recent decades. Global growth opportunities are increasingly found in emerging economies, where the risk of ethical lapses — particularly corruption and bribery — is higher than in more developed markets, in terms of both complying with local legal systems and meeting home-country legal requirements for global operations. Not surprisingly, the percentage of CEO turnovers resulting from ethical lapses is much higher in the BRIC countries than in other regions in our study.
Beyond providing new channels for indiscretion, the use of email, text messaging, and tweets has created new risks for ethical lapses. A company’s digital communications can provide irrefutable evidence of misconduct, and their existence increases the likelihood that a CEO will be held accountable for ethical lapses that occur on his or her watch. A public company CEO who tweets inaccurate information about the company, for example, puts him- or herself at risk for being investigated by the SEC for securities fraud.
Moreover, society’s rising reliance on data and digital technologies — including the rapidly emerging Internet of Things — has outpaced the development of systems, standards, rules, and other measures for mitigating the risks to cybersecurity and privacy that are inherent in the many devices being designed, built, purchased, and used online. Hackers have succeeded in accessing the private data and electronic communications of companies and executives with the goal of exposing unethical or embarrassing conversations and conduct to the public and media.
The changing nature of media has amplified negative news and opinion about businesses and executive conduct. In the 20th century, most executives and companies could maintain a low public profile, and live and work in relatively anonymity. No longer. The lightning-fast flow of Web-based financial news and data ensures that information travels quickly and widely.
What’s more, negative information revealed by whistleblowers, short sellers, critics, and hackers quickly attains global distribution. Companies are now pressured to respond instantly when problems, crises, or inquiries appear in the news, erupt on social media, or arise directly from influential individuals. In this pressure-cooker environment, it’s easy for the removal of the CEO to become the public’s — and eventually the company’s — solution of choice.
An effective culture must clearly state the company’s values of ethics and integrity, but it also needs to ensure that every team — and every employee — understands the critical few behaviors that will enable them to embrace and live those values in the work they do every day.
To reinforce those behaviors, the company’s organizational ecosystem must address the underlying conditions that are always present when employees engage in illegal or unethical acts, by (1) ensuring that the company isn’t creating pressures that influence employees to act unethically; (2) making sure business processes and financial controls minimize opportunities for bad behavior; and (3) preventing employees from finding ways to rationalize breaking the rules. This line of thinking borrows from sociologist Donald Cressey’s classic 1950 conception of the “fraud triangle,” which identified the three elements necessary as precursors to fraud as opportunity, rationalization, and pressure ().
Unethical behavior is typically triggered by some kind of pressure or incentive. Financial pressures (such as bonus packages or stock options) are often assumed to be the primary driver of bad behavior. But this is a misconception. Rather, pressures tend to create larger problems. Employees and managers may be unwilling to admit they can’t meet performance targets. An organization that prides itself on never missing a quarterly earnings target, for example, may inadvertently create this kind of pressure. Companies can inoculate themselves from such concerns by taking the following three steps:
Weak business practices or lax financial controls create opportunities for unethical behavior. Most large companies in developed countries have robust financial controls, and these have been strengthened over the last two decades by the requirements of the Sarbanes-Oxley Act in the U.S. and similar laws elsewhere. Make sure your processes and controls are strong and up-to-date by following three steps: