Curing the ethical malaise in corporate America: organizational structure as the antidote.

Introduction

The new millennium ushered in unprecedented evidence of misconduct in Corporate America (Child, 2002; Kirkland, 2002; Oliver, 2002). The saga began with reports of financial problems in the utopias of some of the most revered corporate images, and stakeholders expressed shock to learn that these acclaimed organizations could have feet of clay. Then hints of overstated earnings began to circulate, along with sharp declines in shareholder value--employees were terminated and their life savings emptied. More corporations fled to bankruptcy courts for protection from creditors and litigation. Shock turned to consternation. It was only when the truth finally unfurled revealing the root cause of these events that public sentiment turned to outrage. Today that outrage is demanding that something be done to cure this spreading malaise. A remedy may be too late; some doubt whether shaken stakeholders will ever regain their confidence and trust in Corporate America.

Malfeasance in Corporate America

Initially, reports that something was seriously awry in the business world only hinted at the shocking revelations to come--the true cause of a growing number of corporate downfalls. Financial difficulties can strike even the best was the common train of thought at the time; that is, until the media explosion began.

Chronicles of worried employees, in a few weeks to be jobless and pensionless after having company-stock loaded 401(k) plans "locked down," began to turn up in Houston newspapers (Fox, 2003, p. 289). Later it was revealed that the lockdown occurred even as some officers of the corporation sold their personal holdings for millions of dollars. But shortly before these shenanigans came to light, an executive's wife appeared on national television tearfully lamenting that she and her husband had lost everything ... "there's nothing left" (Fusaro and Miller, 2002, p. 136). After this never-to-be-forgotten scene on the Today show, the information surfaced that the unscrupulous CEO husband made millions of dollars in early stock sell-offs--one day alone "he sold a total of 78,500 shares for a net gain of over $2.1 million (Bryce, 2002, p. 292). But this was relatively insignificant compared to the fortune he had already socked away over the years.

Employees, unfortunately, were left holding worthless stock options and pension plans. By the time the lockdown on their 401(k)s came to an end, it was too late--there was nothing of value left to sell. Many former Enron employees, dazed by the severity of their predicament, were interviewed by television reporters asking insensitive questions about future plans. But most had no plans, their futures uncertain. Those near retirement age faced years of additional work, if they could find a new job. As Fusaro and Miller (2002) related in their book on the subject:

   Enron's bankruptcy was devastating to
   those who worked there. While those at the
   top of the company were responsible for its
   collapse, they had sold enough of their
   stock to bank away tens and in some cases
   hundreds of millions of dollars. The decent
   people who worked under them would lose
   not only their jobs, but in some cases their
   life savings including the funds in their
   401 (k) plans that they had invested in
   Enron stock (p. xii).

And then more bad news--another major corporation in trouble. This company's CEO, already a multimillionaire, borrowed $408 million from the company, even as earnings slid downward and stock prices fell (Kirkland, 2002, p. 136). This man, another corporate power abuser, also encouraged employees to invest heavily in their 401 (k) plans with company stock; and this company, too, laid off thousands of employees. Top executive officers, however, rose from the corporate ashes with their coffers full. Stories of legendary yachts and multimillion-dollar estates continued to fuel the fire of public outrage.

If there was any doubt at this point that the earlier corporate scandals were flukes, this new offense by a major corporation erased any uncertainties. As one report remarked: "WorldCom put to rest the argument that the corporate scandals were isolated, and fueled the continuing downward spiral of the stock market" ("The Corporate Crime Wave," 2002, p. 5).

But, unbelievably, there were more to come. The incidences of personal avarice among top executives in publicly-held companies flooded the media. A popular business periodical reported that one CEO and his sons irresponsibly used company funds for personal expenditures, such as a $12.8 million golf course and $250 million to meet margin calls. Another CEO, in a pre-fall extravaganza, threw a $2.1 million birthday bash in Sardinia, an event supported by company funds (Kirkland, 2002, p. 138, 123).

Repercussions from Violating the Public's Trust

Initially, it was employees and stockholders directly affected by corporate governance gone amuck who were angry and disillusioned. But then the general public joined in. There was a "massive, widespread and deep sense of public disgust with the corporate wrongdoers" ("The Corporate Crime Wave," 2002, p. 5). Reynolds (2002) described public reaction this way: "What had been a spring shower of criticism of corporate governance in large American companies 18 months ago, pre-Enron, Adelphia, WorldCom, Tyco and the other symbols of excessive corporate power, has become a storm of vitriol" (p. 1).

The result of these debacles was to push the public to the edge. Something had to be done. President Bush (2002) responded to the mounting outrage in a radio address, emphatically stating that "Congress ... must take decisive steps to demand high ethical standards from corporate leaders. Unethical business practices by corporate leaders amount to theft and fraud ... These practices are unacceptable" (Bush, G. W., 2002).

The relationship of ethical conduct to organizations and their stakeholders is a critical one. When ethical misconduct tears this bond apart, the consequences are enormous (Wright, 2002). One result can be loss of competitive ability (Zauderer, 1992) manifesting as grave, often unrecoverable, economic losses for company and stakeholder (Jones, 1995; Stevenson and Oppel, 2002). The second result, equally as serious, is the corruption of the integrity and spirit of the organizational culture. In the case of Enron, reportedly it was the damage to the culture by the unscrupulous demands and practices of the CEO "to make the numbers" at whatever cost necessary, which contributed significantly to the company's financial and legal problems (Kreitner and Kinicki, 2004, p. 107).

With political pressure growing and the stock market falling, Congress responded by drafting comprehensive new legislation to revise federal securities laws, and on July 30, 2002, the President signed the Sarbanes-Oxley Act into law. In January 2003, the SEC issued final rules to accompany this act, establishing additional requirements for "audit committee financial experts" and disclosure of "adoption of codes of ethics" by public companies (U.S. Securities and Exchange Commission, 2003).

Government Solution--The Sarbanes-Oxley Act of 2002. In a radio address prior to the final passage of this act, President Bush gave a preview of the intent behind the new legislation: "The House and Senate have both passed strong corporate accountability bills that toughen penalties and provide transparency and hold corporate executives accountable for their behavior" (Bush, G. W., 2002). He then stated "It's time to act decisively to bring a new era of integrity to American Business." A summary of this act follows in Table 1.

On January 24, 2003, in a summary issued with the final version of the new rules, SEC officials explained they were adopting rules and amendments requiring companies, other than registered investment companies, to include two new types of disclosures in their annual reports. First, the rules require a company to disclose whether it has at least one "audit committee financial expert" serving on its audit committee and whether the expert is independent of management. Second, the rules require a company to disclose whether it has adopted a code of ethics that applies to the company's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions (U.S. Securities and Exchange Commission, 2003).

The Sarbanes-Oxley Act's Effectiveness

Can government actions, in the form of the Sarbanes-Oxley Act, bring back ethical decision-making to the inner sanctums of Corporate America? Displace the power abusers who often rule with unrestrained autonomy? Ferret out corporate officers whose personal greed directly conflicts with long-held principles of shareholder value? Regain public confidence in management? Only time will tell.

But given the critical need to restore ethical conduct, the question of the Act's effectiveness is one in which a wait-and-see attitude is not acceptable to most (Oliver, 2002). Needed now are change interventions that can ensure sustained compliance to new ethical standards. Many doubt that the federal government has the capacity to enforce its legislation--to monitor organizations and their individual endeavors to honestly commit to and continuously support company-wide ethics that equally and fairly apply to all, from the top to the bottom of the hierarchy.

External Versus Internal Solutions

Many believe that if true, lasting transformation is to occur in an organization, the change mechanism cannot be externally imposed but, instead, must be wrought internally, from within the organization (Child, 2002; Mentzer and Swenk, 1990; Tipgos, 2002; Trevino, Weaver, and Brown, 2000; Walsh and Seward, 1990; Wright, 2002; Yukl, 1989, 2002). Several internally initiated changes have recently been proposed, such as the "Boardroom Covenant," which calls for transparency reports from directors on the results of all decisions and activities in a transparent and timely manner (Oliver, 2002, p. 9).

A second proposal for an internal mechanism comes from a panel of the privately funded commission on public trust and private enterprise, headed by Snow, a nominee for U.S. treasury secretary (Bates, 2003, p. 34). This panel released recommendations separating the positions of board chairman and CEO in the effort to improve public trust of business. The group's rationale is their belief that the key issue in the ethics dilemma is equalizing the power between management and board.

A third set of internally derived proposals is calling for new ethical guidelines from organizations and the way these are implemented and monitored. One of the more notable of these efforts is from the Ethics Officer Association (EOA), "the professional association exclusively for managers of internal ethics" (Ethics Officers Association). This group's initiatives focus on equipping ethics officers with the training and knowledge they need to better develop, implement, monitor, and evaluate ethics in their respective organizations. As Raman (2004) recently noted:

   Just as the Interuet era spawned the title of
   chief knowledge officer, the period of
   corporate malfeasance is adding a new box
   to the top tier of the organization chart. The
   new designation on top-job sites: chief
   ethics officer.

Internal Solutions--Who Will Be the Compliance Officer?

Few doubt that new ethical standards, implementation methods, and evaluation criteria are sorely needed in many companies today; and the argument that these must be initiated and subsequently supported within the organization itself makes sense. Although several proposals for internal mechanisms, such as the Ethics Officers' plan, are laudable, they all raise a very serious question: Who within the company will be responsible for ensuring that ethical decisions and policies are implemented and sustained throughout the organization?

To know what is ethical is not the same as doing what is ethical. As Sherron Watkins, the well-known Enron whistle-blower, noted, Enron's "Vision and Values: Respect! Integrity! Communication! Excellence" motto was displayed on brightly colored ceiling banners to encourage employees' commitment (Swartz and Watkins, 2003, p. 5). Apparently, having someone with the clout and oversight capacity to enforce compliance is a key factor in any proposed solution, whether internal or external.

Top Management as Ethics Enforcer: An Ethical Catch-22?

The answer to the question of who will be responsible for ethical compliance is an obvious one: It must be someone sufficiently high in the organizational structure, someone with the legitimate authority to take and support such actions. It must be top management (Pittman and Navran, 2003).

But is this an ethical catch-22, to ask the ones most responsible for the current malfeasance to now lead the way in supporting compliance to more stringent codes of ethics? It seems far-fetched to assume that the Skillings, Lays, Rigas, Kozlowskis, and Ebbers of the corporate world will easily convert to new ways of conducting business that include openness, integrity, and a strong sense of responsibility to others. Masters of secrecy, duplicity, and sleight-of-hand, but not leaders of ethical behavior.

Commonalities among former executive officers. Not all executive officers are unethical; in fact, it is highly probable that most are ethical, even highly ethical. But who is ethical and who is not is difficult to discern. The inability to distinguish ethical behavior from outward appearances was readily apparent in the majority of the ethical malfeasance situations. Few, if any, suspected that these individuals were capable of what they were being accused. Lay, the former CEO and president of Enron, for example, was esteemed in the Houston community as a charitable benefactor and equally well thought of by key national government leaders (Swartz and Watkins, 2003). In addition to being well-liked and respected, the former executive officers all had something else in common: they all led their organizations in almost complete autonomy, making crucial decisions that had dire consequences for the entire organization (Reynolds, 2002; Stevenson and Oppel, 2002).

Centralized Decision Making--A Structural Component

In a hierarchal, vertically structured organization, authority for making critical organization wide decisions is located or "centralized" in the top apex of the organization among the executive officers. A second correlate of a high degree of centralization is the amount of authority held by top management; in this instance, the higher the degree of centralization, the greater the degree of authority or "power" (Daft, 1992). The third correlation is degree of centralization to degree of autonomy, another positive relationship; that is, the greater the centralization, the more decision-making autonomy held by chief officers of the firm (Nadler and Tushman, 1988). Mintzberg (1979), a well-known organizational researcher and theorist, stated that in centralization, "the chief executive officer retains both formal and informal power, making all important decisions himself and coordinating their execution by direct supervision" (p. 208). Refer to Figure 1.

In this characterization of a vertical, bureaucratic structure, it is important to note that to outsiders this type of firm may appear to be less centralized than it actually is, or, in some cases, even de-centralized. This can be the case if teamwork or employee involvement practices or other types of participative management are evident in the organization. However, the true degree of centralization is contingent solely upon the actions of upper administration in making crucial organization-wide decisions. If they are willing to share their authority, delegate it, or seek counsel or confirmation in decision-making, then the firm is less centralized.

In extreme instances of high centralization, top executives may vie for power among themselves and seek to make decisions they believe will best support their individual interests. According to reports, including court testimony, Enron was as an example of this type of situation. Former CFO, Fastow, made critical financial decisions that, at the time they were initiated, were supposedly unknown to members of the board or to Lay, then CEO (Swartz and Watkins, 2003). From these decisions, Fastow was able to greatly enrich himself through what has become widely known as the "Chewco seam," one of several off-balance-sheet financing maneuvers (Bryce, 2002; Elliott & Schroth, 2002). (Update: Fastow eventually pied guilty and plea bargained for a reduced sentence; and, although Skilling, president and then CEO, has denied any knowledge of Fastow's financial manipulations, he is now facing a 35-count indictment.)

Decentralized Decision Making--A Structural Component

In contrast to centralized decision-making, management's intent in decentralizing is to allocate responsibility more widely throughout the structure, both vertically and horizontally. A second distinction is made between the forms of decision-making in centralized and decentralized structure: The decentralized decision-maker is expected to share with others in the making of decisions and their results. Autonomous decision making, especially in important matters, is not rewarded and may even be penalized if the decision outcome is negative. But similar to centralization, decentralization is also carried out in varying degrees, dependent upon management philosophy and strategic objectives.

The primary rationale for decentralization in today's complex and dynamic external environment is to equip the organization to respond more quickly to customers and rapidly changing competitive threats. Instead of waiting for an important question to make its way up through the levels of a bureaucratic structure to executive officers and then wait for their response to make its way down, it is possible through decentralization to respond immediately to the situation. The increased response time gained from a decentralized structure can mean the difference between success or failure (Cravens and Shipp, 1994; Daft, 1992; Dess and Rasheed, 1995; Dyer, 2002; Hankinson, 1999; Hitt, Keats, and DeMarie, 1998; Krachenberg et al., 1993; Ostroff, 1999; Pound, 1995; Stanford, 2002).

In the literature, decentralization is known by numerous terms, often used synonymously. Among these are participative or democratic management, employee involvement (EI), and team-based practices to denote governance philosophies, while the fiat or horizontal organization represents the type of structural design. Other terms referring to the decentralized structure as organic or flexible. In contrast, the centralized structure is sometimes referred to as vertical, bureaucratic, mechanistic, rigid, or inflexible. (Refer to Figure 1 for a view of the general decentralized structure.)

Differences in Centralization versus Decentralization: Significance to Ethical Decision-Making

The connection between organizational structure and ethical decision making is strongly related to two factors: (1) the locus of decision-making responsibility, and (2) the opportunity provided to further one's own self interest, regardless of whether it is are in the best interest of the organization. Importantly, both the locus of decision-making power and the opportunity to be self-serving can be directly shaped through organizational design modifications. What is not within the control of organizational structure, and arguably not within the control of any imposed mechanism, is an individual's propensity to make unethical decisions to further personal interests.

* Locus of decision-making responsibility. Centralization and decentralized structures differ extensively in how the lines of decision-making responsibility are drawn. A centralized structure locates primary authority for crucial decision making at the top with the chief executive officers. A decentralized structure is purposely designed to distribute or "share" decision-making in varying degrees.

* Opportunity provided to further one's self-interest. In a centralized structure, especially a highly centralized one, there are opportunities to make decisions that further one's personal interests. The occurrence of these opportunistic situations is inversely correlated to the degree of decision-making locus in the organizational design; that is, the smaller the locus, the greater the opportunity. In this situation, a positive relationship exists between the individual's level of authority and the potential for opportunistic action to increase one's personal interests; that is, the higher the level, the higher the potential return when opportunistic actions are taken. For example, Fastow, the former CFO at Enron, was able to convert millions of company dollars into personal funds (Bryce, 2002).

In contrast, a decentralized structure diminishes opportunities to further one's own interests. In this case the relationship between the degree of decision-making locus and the opportunities to promote one's own interest is inverse; that is, the more decisions are shared the organizational design, the fewer the opportunities to act independently in one's own interests. In decentralization, due to increased accountability from shared decision outcomes, the relationship between the level of authority in the structure and the potential of opportunistic action becomes irrelevant.

A number of theorists have stressed the relationship between decentralized decision-making and ethical behavior (Bennis, 2002; Daboub, et al., 1995; Holtzhausen, 2002; Mayer & Davis, 1995; Metzer and Schwenk, 1990; Nesteruk, 1991; Ocasio, 1994; Yukl, 1989). Among these theorists, the two who make the strongest plea are Collins (1997), who speaks of the "ethical superiority of participatory management," and Sashkin (1984, 1986), who believes that "participative management is an ethical imperative."

Conclusion: Adapt the Organization Structure to Support Ethical Decision Making

To cure the ethical malfeasance in Corporate America, a number of interventions are advocated. The most comprehensive external proposal by far is the federal government's recent law, the Sarbanes-Oxley Act of 2002. This legislation tries to make corporate officers more accountable by mandating new accounting regulations aimed largely at transparency and also by ensuring that every organization has an explicit code of ethics. But organizational theorists seem to concur that the intervention of choice must be internally initiated, rather than externally imposed, if true organizational change is to occur and be sustained.

The internal inventions that have been proposed focus mainly on relationships between the board and CEO. However, a mounting grass roots effort led by the Ethics Officers Association calls for every organization to have a chief ethics officer (EO) to set ethical standards and advise upper management. Although these proposals have laudable objectives, they are hard to execute because, in each case, the proposal hinges on commitment and compliance from top management, the same group responsible for the ethical crisis.

Singling out this group as culprits does not imply that all executive officers are unethical. On the contrary; the intention is to underscore the point that it is the primary organizational decision-makers who must stand behind ethical choices, see that they are implemented, and ensure continuous compliance.

If the cure for ethical malfeasance is to come from the primary organizational decision-makers, then let us choose a form of organizational decision-making that can sharply narrow the opportunities to act in unethical ways to pursue individual self-interests. The form of choice is clearly the decentralized structure, in which decision-making and accountability are shared.

Unbeknownst to co-workers, the corporate world may still have its Fastows, Skillings, and similarly inclined individuals; the probability is the same as in the past that individuals such as these exist. But by designing the organization to support ethical decision-making, unscrupulous individuals will no longer pose the same threat. In one word: Decentralization. This is obviously not an appeal to the better nature of mankind but, instead, a workable proposal.

Dr Stanford, a visiting associate professor of management at Texas A&M University-Corpus Christi, is the president and principal consultant of Strategic Management Solution, Inc.

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Jane Herring Stanford, Texas A&M University-Corpus Christi