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Moral Leadership David Cherrington Sacramento Management Society 12 November 2008


Conclusions of our first honesty studies: 1980 1. Dishonesty is the greatest threat to America’s economy. 2. You cannot be a great transformational leader unless you are a moral person.


#1 What is America’s greatest economic threat?       

Balance of trade Federal budget deficits Plunging stock market Inflation Interest rates Unemployment Energy costs

Dishonesty


Income Tax Cheating 

The 2004 tax gap was between $312 - 353 bil. [“Tax Cheating is on the Rise, Treasury Says”, Wall Street Journal, 30Mar05, p. D1]

“The government sent out more than $1 billion in fraudulent tax refunds last year, and the Internal Revenue Service has too few resources to pursue every tax fraud case, according to a Treasury Department Report. The number of improper refunds filed appears to be growing rapidly… ‘The problem is becoming unmanageable, and the IRS cannot afford to continue handling it in the same manner as in the past’” [“Fraudulent Tax Refunds Top $1 Billion” Wall Street Journal, 31 Oct 2008, A13]


The Cost of Corporate Fraud The cost of the 2008 federal bailout is $810 billion  “U.S. employers will lose about $994 billion to fraud this year, suggests a study by the Association of Certified Fraud Examiners. More than half of the 959 white-collar crime cases analyzed were discovered by accident.” [Businessweek, 13Oct 08, p. 16] 


Mortgage Mess        

Lenders advertised easy-to-pay loans, e.g. ARMs House appraisers inflated the values of homes People bought bigger homes than they could afford Loan officers gave loans to people they knew did not qualify Banks were induced to revise their loan requirements for identity and income verification Hedge fund managers got paid $100-400 million to create packages of mortgages. Wall Street investors got $100 mil for selling hedge funds Freddie and Fannie paid legislators to avoid regulation


#2 Moral leadership ď Ž

You can’t be a great transformational leader if you are not a moral person.


Graduation Speech at West Point 

“Great leaders must be trustworthy; no man who is unfaithful to his wife can be a truly great military leader.”

Author: unknown Date: unknown Place: questionable

 


Officers in the Korean Demilitarized Zone 

“We could tell by their performance reports almost exactly when they started fooling around with the women in town.”

Author: Ranking Officer in the Korean Demilitarized Zone for Seven Years during the 70’s Date: August, 1981 Place: American Psychological Association Meetings in Los Angeles

 


A female student who served in Bosnia, 2001 ď Ž

“Before we were assigned to Bosnia, we had the highest performance rating of any unit. But eight weeks later our unit fell apart when our commanding officer began an affair with another member of our unit. It was terrible! No one felt safe and everyone was transferring out. How do you trust someone who is dishonest and deceitful? How can you serve under someone who can force you to put your life on the line when you know he is not an honorable person.


Leadership ď Ž

Leadership: is the incremental influence one individual exerts over others above and beyond mechanical compliance.


CEO Disease Narcissism (“self-love”): Leaders become infatuated with their position and status  Series of Successes: past success seems to guarantee future success  Uncritical Acceptance of Accolades: everything they do is praised  Exemption from the Rules: rules are for others. 


Transactional Leadership Establishes goals and objectives.  Designs work flow and delegates task assignments.  Negotiates exchange of rewards for effort.  Rewards performance and recognizes accomplishments.  Searches for deviations from standards and takes corrective actions. 


Transformational Leadership  

Charismatic: Provides vision and a sense of mission, gains respect and trust, instills pride. Individualized consideration: Gives personal attention, and treats each person individually, coaches. Intellectually stimulating: Promotes learning, encourages rationality, uses careful problem solving. Inspirational: Communicates high performance expectations, uses symbols to focus efforts, distills essential purposes.


…but, what about…? Were they really great leaders or did they occupy a critical position at a critical time?  How much better could they have been if they had been people of high moral character? 


Principles of Moral Leadership Communicate an expectation of moral behavior

Ask followers to describe their values

Model moral behavior

Talk about heroes

Moral Leadership

Respect the autonomy and agency of others Identify the moral dimensions of the situation

Use misbehavior as a teaching moment Use moral vocabulary Reward integrity through praise and recognition

Build healthy interpersonal relationships

Describe the consequences of alternatives


Definition of Organizational Culture Socially acquired rules of conduct that are shared by members of the organization, as found in its artifacts, norms, values, and assumptions.


Levels of Organizational Culture High

Level of Awareness

Norms Situation specific rules of conduct

Values Generalizable goals, ideals, standards

Assumptions Taken for granted beliefs concerning: Human Nature, Relationships, Truth, etc.

Low

Artifacts Verbal Physical Behavioral


Cultural Contrasts 

Ethical Leadership Conference  Artifacts  Behaviors  Values  Shared

assumptions

versus  Rock Concert  Artifacts  Behaviors  Values  Shared

assumptions


Examples of Cultural Assumptions 1.

2. 3.

4.

The Nature of Relationships: Are the relationships between people primarily hierarchical, group-oriented, or individualistic? Human Nature: Are people basically good, basically evil, or neither good nor evil? The Nature of Truth: Is “truth� (i.e. correct decisions) discovered from external authority figures, or is it determined by a process of personal investigation and testing? The Environment: Do people master the environment; does the environment control people; or should they try to harmonize with the environment?


Honesty as a Cultural Assumption: Which one do you believe, A or B? A: People are basically honest and can be trusted to tell the truth. They do not take things that do not belong to them; nor do they give false impressions or try to take unfair advantage of others. People can be trusted to monitor their own moral conduct. B: People are basically dishonest and will lie, cheat, and steal whenever it is expedient, if they think they can avoid being caught. To prevent dishonesty, people must be monitored and valuables must be secured. It is the company’s responsibility to prevent theft.


Illustration of a Dishonest Cultural Assumption: Conversation with a trucking company CEO  “You really need to learn that operations research stuff. We use it all the time to tell us how much to overload our trucks. We have a formula showing that we can maximize our profit by running them two and a quarter tons heavy.”  “But, what if you get caught?”  “Of course we’re going to get caught! We know we’re going to get caught, and we know what the fines will be. We put all this in our formula.”  “Aren’t you afraid of prosecution?”  “Heavens no! You don’t put an entire trucking company in prison. This is just a money game – how do you maximize profits?”


ď Ž

What are the differences between a culture of honesty and one of dishonesty?


Contrasting Cultures When companies assume people are honest:  Supervisors trust people employees to do their assigned jobs without constant checking.  Employees are trusted to resolve customer problems and build relationships.  Employees provide timely feedback and offer creative suggestions.  Employees feel empowered to build the company.


Contrasting Companies When companies assume employees are dishonest:  Employees are not given complete information about the company or their positions in it.  The performance of employees is closely monitored and controlled.  Control systems are more visible and repressive.  Interpersonal relationships are more distant and suspicious.  There are greater “transaction costs” with employee groups and other companies.


Chain of Consequences Ethical decisions create trust  Trust is essential for commitment and dedication  Commitment and dedication create motivation and effort  Motivation and effort build organizational success. 


Impact of a Culture of Honesty on Inventory Shrinkage Rates Study of 22 retail stores  Shrinkage rates WERE NOT related to the external crime statistics in the surrounding neighborhoods  Shrinkage rates WERE related to the attitudes of employees regarding honesty  Shrinkage rates and attitudes of honesty WERE related to the Culture of Honesty within each store 


Measuring a Culture of Honesty 5-point scales, Strongly Agree to Strongly Disagree  The top management in this company has a very high, well-defined standard of honesty.  Our company has a very explicit code of ethics.  Most of the employees around here would steal if they got a chance. ®  This company is not very concerned about honesty and does not care much about it so long as the amounts are small. ®  Most employees do not get prosecuted for stealing even when they get caught. ®  It would be extremely difficult to steal from this company without the theft being discovered.  Some of the people I work with would probably help me steal from the company if asked them. ®


Measuring a Culture of Honesty…    

  

In some situations, there are good reasons why it is all right to steal from the company. ® I am the kind of person who would let a good friend use my employee discount. ® There are no real incentives encouraging me to report thefts or help to prevent them. ® I feel a personal responsibility to prevent dishonesty among my co-workers; every employee should be a bit of a “watch dog.” If I knew another employee had stolen something, I would tell on him. Taking company property without permission is a common practice at this company. ® There is a critical need to raise the standards of honesty and integrity in this organization. ®


ď Ž

Does a culture of honesty really matter?


Illustrations of Dishonest Cultures: American Woolen Kickbacks on dyestuffs  Graft on the purchase of raw materials  Personal expenses were charged to the company  Corruption cascaded throughout the management hierarchy 


Illustrations of Dishonest Cultures: Equity Funding Unrealistic growth goals  Co-insurance contracts  A decade of deceit by a department of 75 employees and managers who fabricated policies  Using life insurance policies on “deceased” people to pay for group parties  The corruption extended to the individual lives of the employees. 


Illustrations of Dishonest Cultures: Tyco Industries 

Executive perks that knew no limits  $30

million apartment  A yacht  Expensive jewelry  Art works 

CEO Dennis Kozlowski spent $2 million in company funds on a toga party in Sardinia to celebrate his wife’s birthday.

Source: Wall Street Journal, 20 June 2005, A10


Illustrations of Dishonest Cultures: U.S. Military Contractors in Iraq A contractor charged the U.S. $3.3 million for phantom employees assigned to an oil-pipeline repair contract.  Iraqi construction firms allegedly paid U.S. soldiers to help steal construction equipment from the interim government.  At least a third of the government-owned vehicles and equipment that Halliburton was paid to manage were believed lost.  The U.S. failed to keep track of nearly $9 billion it transferred to the new Iraqi government, much of which appears to have been embezzled. Source: Wall Street Journal, 26 July 2005, A1. 


 

In 2007, Army Major John Cockerham made more than $9 million by taking money from contractors in return for steering big-ticket government deals their way. His replacement, Major James Momon, pleaded guilty to pocketing over $1 mil. Other payments range from $5000 to $9 mil.

Source: “U.S. Bribery in Iraq,” Parade 26Oct08, p. 6


“I think the most disheartening part of fighting this war is not the insurgent attacks and roadside bombs. It’s all the corruption that you see going on all over the place. We just can’t seem to stop it and no one really seems to care enough. It’s very discouraging to a lot of people.”

Source: Personal communication


Illustrations of Dishonest Cultures: American Insurance Group - AIG 

 

The company has admitted beautifying its income statement by playing games on its derivatives trading desk and vastly understating its loss reserves. Ex-CEO Hank Greenberg: “All I want in life is an unfair advantage.” “There was a disdain for regulators, and it fostered a corporate ethos that wasn’t good for the company.”

Source: Devin Leonard and Peter Elkind, “A Fortune Investigation,” Fortune, 8 Aug 05: 76-96


“When all else failed,… AIG simply made numbers up. CFO Smith created fictitious ‘topside’ adjustments, increasing reserves to the levels analysts wanted ... Smith personally directed the changes, rattling them off to a subordinate who jotted them down in a spiral notebook… ‘For quarter after quarter,’ says the complaint, ‘AIG’s official books and records were altered on the basis of nothing more than Smith’s say so and the handwritten sheets, with hundreds of millions of dollars shifting from account to account.’”

Source: Devin Leonard and Peter Elkind, “A Fortune Investigation,” Fortune, 8 Aug 2005: 76-96.


Illustrations of Dishonest Cultures: Enron ď Ž

Enron used off-shore investments to protect its balance sheet and hide debt.

ď Ž

BUT, its accounting irregularities were spawned by a unique culture that was out of control.


Enron’s Downfall “But a prime suspect [of the cause of this fraud] is the culture of Enron itself -- a potent brew of aggressiveness and powerful intellect, fearlessness toward risk and a disregard for anyone who dared question the inner workings of the corporate juggernaut. Fond of billing itself as the "World's Leading Company," ambitious Enron seemed to acknowledge no limits to its prowess.” By GREG HASSELL 2001 Houston Chronicle


How did Enron’s human resource policies contribute to its collapse? 

First, they changed their selection criteria to create a new corporate culture  From

a slow, stodgy, regulated energy bureaucracy to a fast-paced, entrepreneurial, free-capital enterprise.  Employee selection focused on hiring the best and the brightest – rather than hiring engineers and accountants, they hired finance and investment banking students, especially MBAs


Second, they promoted from within using fast-track promotions – 20% of their turnover was from internal promotions  Pressure

for earnings growth  Pressure on short-term results  Pressure on perceived promotability, e.g Lynda Clemmons.


Illustration of Quick Promotions Lynda R. Clemmons, age 27 in 1997, (SMU graduate in French and history) launched an esoteric enterprise in weather derivatives. Within two years her startup had written $1 billion in weather hedges to protect companies against short-term spikes in the price of power during heat waves and cold snaps. She went from analyst, to associate, to manager, then director, and finally to vice-president running her own business all in seven years.


Third, performance reviews were brutal and dysfunctional  “Rank

and yank” – the people in each department were rated each year and the bottom 15% were terminated.

 Managers

were evaluated by a Performance Review Committee of 20 executives.  

Top 5% were rated superior - $1 mil bonuses Next 30% were rated excellent - $200k - $500k bonuses

 The

evaluations destroyed group cooperation and created groupthink


Fourth: They abolished seniority-based pay and replaced it with a pay for performance system with huge cash bonuses and stock options  Pressure

to look good  Pressure to keep stock prices up  Pressures for earnings growth


Fifth, they created a management style of empowerment and control – “loose and tight”  Young

MBAs could authorize $5 mil decisions with no review  They focused on managing by the numbers.  The pressure for quarterly performance was absolutely intense.


Illustration of Quarterly Earnings Pressure "We were looking to do a deal to supply energy to HISD (Houston's public school district), and I explained to them that it would take a year to educate the school district and make it comfortable with changing the way it got its power," said George Strong, a lobbyist who worked for Enron for 25 years. "The guy I was working with -- he was a director in his late 30s -- started yelling, `I don't have a year! My bonus is based on what I do this quarter. If I can't get it done in three months, I don't have time for it.' " Source: Greg Hassell, Houston Chronicle


Illusion of Invulnerability "They became like the Taliban. They were the holy ones. No one was as smart they were," a former senior executive at Enron said. "Anyone who criticized Enron -- internally or externally -- was taken out and flogged."

"If you worked at Enron, you thought you were better. You were smarter than everyone else," said a former employee who admits she fell under the Enron spell.


"They were arrogant. They felt they were the king of the hill, and they didn't mind letting you know that," said Bob McNair, founder of Cogen Technologies, an energy business he sold to Enron for $1.1 billion.

“That arrogance had many ramifications. One of the most costly was that it prompted Enron executives to believe they could tackle any business and master it. So Enron plunged into everything from broadband to water to coal to paper to steel.�


Illusion of Morality "Enron sought to redefine the rules of the industry," said Robert Bruner, a professor at the University of Virginia who has made a case study of Enron's culture. "It was culture of challenge and confrontation."


Consequences of Enron’s Fall 

Arthur Anderson was destroyed. From the time it was founded 88 years ago by a well‑respected Northwestern University accounting professor, Arthur Anderson was one of the most highly respected accounting and consulting services companies in America. Its involvement with Enron sounded the death knell for this venerable, once highly respected company.


Implications of Enron’s Collapse   

Thousands of employees lost their jobs and their life savings Thousands of investors lost millions in their retirement savings Other companies were seriously injured, especially Canadian Imperial Bank of Commerce, J.P. Morgan, Citigroup, Credit Suisse First Boston, and Merrill Lynch. The economic recovery was impeded.


ď Ž

How do you create a culture of honesty?


Illustration of Culture Building: J. C. Penny - Orem Inventory shrinkage of 0.2% for eight years  “Expectations” by management  Excellent leadership by a great transformational leader  New employee orientation  Management by walking around 


Illustration of Culture Building: Pacific Security National Bank Development of a code of ethics  Employee involvement in submitting ethical issues  Employee participation in the ethics committees  Discussions of the code of ethics with employees and their agreement 


Illustration of Culture Building: LDS Church 

Clearly defined internal control procedures  Who

receives financial contributions  Who processes financial contributions  How the funds are deposited  How disbursements are made  Maintenance of receipts

Regular audits and oversight  Regular reports to multiple officers 


Illustration of Culture Building: Tyco Enterprises       

Hired a new CEO, Ed Breen Replaced the entire board of directors Instituted an internal audit staff of 110 people who reported to the new board member Established an 800 number for reporting wrong-doing to an ombudsman Fired 290 of 300 highest-ranking managers Refused to pay bonuses until the criteria were reviewed. Bonuses decreased from $355 mil to $183 mil. Hired independent attorney to review all internal records


Illustration of Culture Building: Bristol-Myers Deferred prosecution for channel stuffing and financial misrepresentations  Admission of wrongdoing  Full cooperation  Willingness to disclose 


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