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Tone at the Top
20 min

Tone at the Top

 

Introduction

In early 2000’s a number of high-level corporate scandals[1] threw the business world into an ongoing turmoil, causing losses of colossal scale, exposing years of systematic abuse of power and dishonest business practices, and eventually loss of public confidence in global organizations and how they operate. The companies in question included Enron, WorldCom, Adelphia Communications in United States, CINAR in Canada, Swissair in Switzerland, Parmalat in Italy, FlowTex in Germany, MG Rover Group in UK, Tyco International in Republic of Ireland, and many others. As we can see from the geographical distribution, the issue could be defined as a worldwide concern.

 

Almost all of these corporate collapses were to some extent associated with the top management – with widely exercised corrupt practices, at best “questionable” methods in achieving corporate, or - as in the most cases - one’s personal objectives. In addition, the lack of adequate internal control environment and proper corporate governance also contributed to the widespread abuse, violations and exploitation of accounting loopholes.

These high-profile scandals eventually popularized and emphasized the definition of the “Tone at the top”[2], as a preventive and guiding initiative in setting the right environment and culture in the organizations. Particularly, several countries adopted legislative measures targeted to reduce the misconducts and define more rigorous and effective means of control. The most well know of such regulations is of course the Sarbanes–Oxley Act (SOX)[3], that went into law on July 2002, as well as U.S. Federal Sentencing Guidelines[4]. Among other, these legislations set guidance to enforce and promote the term “Tone at the Top”. SOX section 404, for instance, sets out the responsibilities regarding risk management, i.e. the audit and reporting of internal control system within a company. In SOX terms, management refers to the board, with specific emphasis on the CEO and CFO - these individuals have to attest that the control system has been reviewed. It should be emphasized, that in direct contrast to other corporate governance systems, responsibilities defined by SOX are statutory, rather than guidance.

Other examples are The Organization of Economic co-operation and Development (OECD), which issues the Good Practice Guidance[5] document, urging companies to promote a comprehensive system of ethics and a culture of integrity, the International Corporate Governance Network (ICGN)[6], which promotes effective standards of corporate governance and investor stewardship, through its set of principles, and finally the Committee of Sponsoring Organizations (COSO), which adopted provisions to its original guidance, promoting ethics and culture as integral part of a comprehensive framework for reputation risk management.

All these regulations particularly emphasize “Tone at the top” as an essential baseline.

Now let’s discuss what the “Tone at the Top” is and why it is important for organizations.

 

What is “Tone at the Top” and why does it really matter?

 

In general, people may behave in a noncompliant manner for various reasons;

(1) noncompliant behavior without specific intention,

(2) noncompliant behavior to benefit the organization, and

(3) noncompliant behavior to benefit oneself.

To effectively prevent noncompliant behavior, it is crucial to understand what facilitates it. Consequently, if the organization also profits from such behavior, employees can more easily justify their noncompliant behavior morally, because they can interpret the rule violation as desirable from the company’s perspective as well. In particular, in a business context, employees use the excuse that “everyone is doing it” to morally disengage from noncompliant actions.

Prior research shows that the tone at the top — top management‘s way to express ethical values pursued in the organization and provide guidance to employees is the main factor to shape and predict the ethical behavior.

"Tone at the top" is a term used to describe an organization's general ethical climate, as established by its board of directors and senior management. It sets the organizations guiding values and principles. It is the most important component of the control environment. The tone at the top is set by all levels of management and has a trickle-down effect on all employees of the organization. If the tone set by management upholds honesty, integrity and ethics, employees are more likely to uphold those same values.

In general, Tone at the Top is about creating a culture where everyone has ownership and responsibility for doing the right thing. It is leading with integrity and by example.

Weaknesses in the "Tone at the top" have been associated with most modern financial frauds. Poor tone at the top may include a negligence for internal controls, an overemphasis on profits at the expense of ethics, a belief that compliance with the law is sufficient for defensible ethical conduct, the accommodating of some stakeholders but not others, blaming higher-ups or colleagues for unethical practices, having one's judgement clouded due to conflicts of interest, and a misunderstanding of and lack of adherence to public expectations of what constitutes ethical behaviour for executives.

To ensure a proper tone at the top, the management and those charged with authority must implement a number of adequate measures. Among these, the following components may be highlighted;

Lead By Example:

Setting the proper tone starts with managers at all levels leading by example and with integrity. Leaders should demonstrate through their own actions their commitment to honesty, ethical strength, reliability, and fairness. Management cannot act without these qualities and expect others to behave differently.

 

Communicating and Promoting Ethics and Values:

Management must clearly communicate its ethics and values throughout the area they manage. These values could be communicated formally through written codes of conduct and policies, staff meetings, memos, etc or informally during day to day operations.

 

Reporting:

It is crucial to create channels for employees who are witnessing unethical behavior to be able to report such behavior. Employees are responsible to report such activity to management and should feel safe from retaliation. Managers should make their employees aware of the Reporting Hotline and encourage them to use the channels whenever a misconduct is determined.

 

Reward Integrity:

It is also important to recognize employees who demonstrate honesty and integrity. Doing so will help communicate management’s commitment to this behavior and will encourage others to act in the same manner. This will promote integrity and make a positive influence on others.

 

Embedding systems and processes to support the Tone from the Top:

Implementing and promoting ethical tone as "business as usual", will help shape the organizational culture and measure the effectiveness of leadership actions and behaviors over a period of time

 

Each level of the organization management should have its share of accountability, which will help to shape and maintain the strong corporate governance in the company.


The act of having a profound corporate governance under the Sarbanes-Oxley Act, requires clearly define the roles and responsibilities of the Board, directors, CEO and other officers, strengthen audit committees, perform internal controls tests, make directors and officers personally liable for the accuracy of financial statements, and strengthen disclosure.

 

 

Corporate Governance (What are the roles of Board, CEO, CСO)        

 

Corporate governance is the system by which organizations are directed and controlled. It encompasses the relationship between the board of directors, shareholders and other stakeholders, and the effects on corporate strategy and performance. Corporate governance is important because it looks at how these decision makers act, how they can or should be monitored, and how they can be held to account for their decisions and actions.

Governance refers specifically to the set of rules, controls, policies, and resolutions put in place to dictate corporate behavior. Shareholders are important stakeholders who indirectly affect governance, but these are not examples of governance itself. The board of directors is pivotal in governance, and it can have major role in setting the proper tone and cultural environment throughout the whole organization.

 

The Board

A Board must act in good faith in the exercise of its oversight net responsibility for its organization, including making inquiries to ensure: (1) a corporate information and reporting system exists and (2) the reporting system is adequate to assure the Board that appropriate information relating to compliance with applicable laws will come to its attention timely and as a matter of course. The existence of a corporate reporting system is a key compliance program element, which not only keeps the Board informed of the activities of the organization, but also enables an organization to evaluate and respond to issues of potentially illegal or otherwise inappropriate activity.

Boards are encouraged to use widely recognized public compliance resources as benchmarks for their organizations. The Federal Sentencing Guidelines (Guidelines) and OECD god practice guidelines can be used as baseline assessment tools for Boards and management in determining what specific functions may be necessary to meet the requirements of an effective maintenance of the tone at the top. The Guidelines offer incentives to organizations to reduce and ultimately eliminate criminal conduct by providing a structural foundation from which an organization may self-regulate its own conduct through an effective compliance and ethics program.

Although compliance program design is not a "one size fits all” issue, Boards are expected to put forth a meaningful effort to review the adequacy of existing compliance systems and functions.

 

Boards should develop a formal plan to stay abreast of the ever-changing regulatory landscape and operating environment.

From the compliance perspective, among others the boards must also conduct the following activities:

  • Define the roles and relationships, including those of Compliance function, Legal function, Internal audit, Human resources, the quality improvement function, etc
  • Board should set and enforce expectations for receiving particular types of compliance-related information from various members of management, regarding the organization risk mitigation and compliance efforts.
  • Identify and audit potential risk areas
  • Encourage accountability and compliance.

 

Some of the corporate failures included instances when directors were paid excessive bonuses (for instance MG ROVER Group), while the company was facing times of economic and operational downturns. Such instances were perceived by the general public under a negative light and had a declining effect on the company’s reputation. To overcome such issues, there should be a remuneration committee (at least in large or public organizations), which will determine the adequate and transparent level of remuneration, and ensure that no excessive salaries are being paid to the directors and officers.

 

From the ethical tone perspective, the Board’s most important responsibility is the selection and appointment of Corporate Officers, particularly the Chief Executive Officer (CEO), who is the face of the organization and the gatekeeper of its reputation.

 

The CEO

As it was outlined in the earlier paragraphs, the executive officers and particularly CEO’s were the main figures behind the large corporate failures of the early 2000’s. More than any other individual, group or function in the organization, the chief executive sets the tone from the top through messages, conduct and other activities that affect factors related to the control environment and corporate culture. The CEO is the face of organizations, the person to whom employees turn their look for vision, guidance and leadership.

Organizational values affect the decisions people make, and ultimately, the path of the company. The CEO’s role is to clearly define these values and ensure that they are embodied throughout the organization. Every company has unique values, and it’s up to CEOs to establish them in a way that permeates to every individual. This starts with getting buy-in from senior leadership to help shape the culture. Values are also reinforced through CEO behaviors such as attending development programs, participating in group discussions, and generally being present and accessible. Defining values doesn’t happen by sending a single memo; it happens when you behave, act, and make decisions in ways that support those values on a consistent basis.

When employees see the CEO behave in a way that demonstrates company values, it resonates and encourages them to do the same. On the other hand, when they see discrepancies, it tells them that their behavior doesn’t matter because the CEO is not walking the talk, therefore it is essential for a CEO to be consistent both in his/her actions and communications.

 

The CCO

The role of Chief Compliance Officer (CCO) in setting the right tone at the top is significant, if not to say critical. The person must be a High level individual, with appropriate authority, to reinforce the required tone at the top and maintain a necessary level of corporate culture. The CCO must have adequate resources and tools, to ensure that ethics and compliance program is effective and sustainable. The role of CCO is essential in such areas as education/training, communications, background checks, reporting, policy and procedure development. 

The CCO is also the leader that employees seek out when they have ethical concerns. Therefore, he or
she plays a crucial role in creating a "speak up" culture – an essential element of tone at the top.
In addition, the best CCOs seek out opportunities for the CEO to convey key ethics and compliance messages in both internal and external communications. He or she also proactively assists the board in both understanding and executing their role in setting the tone at the top.

Over the years, a number of organizations that have experienced ethics or compliance crisis, have ramped up their compliance efforts for a specific period of time. Later, when the “storm has passed”, they reduced the CCO’s role to more of an administrative one. Clearly, this kind of short-term response is exposed to a danger, and can send a strong negative message to employees and regulators about what matters most and how an organization conducts itself when it believes no one is watching. Organizations that take compliance seriously task their CCOs with developing processes and a mindset that weave integrity into the DNA of the organization.

 

The Company Secretary

The role of Company Secretary is mainly administrative, however he or she can also be an excellent figurehead in setting the proper Tone the at the top. The Secretary can be responsible for advising the board on corporate governance and ethics/compliance related matters, ensuring board procedures are followed. Additionally, he or she will ensure, that board decisions are communicated to staff and outsiders.

Company secretary may act as the general administrator and head office manager. This role may include a responsibility for maintaining fair and reliable accounting records, corresponding with legal advisers, tax authorities and trade associations. As a representative of the company’s stewardship function, he or she will always act in the interests of the company in any event of conflict or dispute with directors.

 

Beyond the roles described above, it is also critical for senior leadership to act as role models through their behaviors, actions and words to encourage and motivate others to do the same - after all, if senior leadership do not "do as they say", why should anyone else? Leaders must not only be judged for their technical competency to lead but also by their ability to understand the need to act with integrity and deliver the right culture.

 

 

Tone at the Top and Corporate Culture

 

The proper tone from the top is critical, but it will dissipate fast unless there is a genuine and ongoing commitment from the board and senior leadership, including the chief compliance officer and the chief audit executive, to send the right message using various media, as well as building relationships throughout the organization one at a time. Without the right tone from the top, and without clear communication of the message, you could be encouraging misconduct. These are the building elements of a healthy and sustainable environment, which eventually shapes the corporate culture of the organization.

Culture is the set of shared attitudes, values, goals, and practices that characterizes an institution or organization. It is the extent to which an organization regards its values. Strong ethical cultures make doing what is right a priority. Ethical culture is often unwritten code by which employees learn what they
should think and do. Cultural norms define what is encouraged, discouraged, accepted, or rejected within a group. When properly aligned with personal values, drives, and needs, culture can unleash tremendous amounts of energy toward a shared purpose and foster an organization’s capacity to thrive.

Visually, the corporate culture of the organization can be presented as an overlapping diagram of the following items;  

Some of today’s best organizations promote ethics and culture as a critical part of their corporate branding and values. This is because doing the right thing, even when no one is watching, is profitable – this is called the “ethical premium”[7]. Several studies have examined the correlation between organizational justness and performance, and the results show that those organizations with morals and ethics often outperform their competitors.

The Business Benefits of Culture, that organization may enjoy, include among others the following;
 

  • Increased reputation and positive public image
  • More stable and consistent reaction to ever-changing rules/laws
  • Social media regulations
  • Effective recruitment and reduced turnover
  • Less disruptive workplace.

 

Creating a culture of integrity begins with tone at the top, but it has to include the mood in the middle and the buzz at the bottom. Culture is what people see as recognized and rewarded. For employees, the face of culture might be their supervisor. Therefore, the senior leadership should act as the driver of corporate culture and its crucial contributor.

A leader can be a manager, but a manager is not necessarily a leader. The leader of the work group may emerge informally as the choice of the group. If a manager is able to influence people to achieve the goals of the organisation, without using formal authority to do so, then the manager is demonstrating leadership.

The key point in differentiating between leadership and management is the idea that employees willingly follow leaders because they want to, not because they have to. Leaders may not possess the formal power to reward or sanction performance because leadership does not necessarily take place within the hierarchical structure of the organisation. However, employees give the leader power by complying with what he or she requests. On the other hand, managers may have to rely on formal authority to get employees to accomplish goals.

 

Some scholars proposed that there are two types of leaders:

  • Transactional leaders see the relationship with their followers in terms of a trade: they give followers the rewards they want in exchange for service, loyalty and compliance.
  • Transformational leaders see their role as inspiring and motivating others to work at levels beyond mere compliance. Only transformational leadership is said to be able to change team/organizational cultures and move them in a new direction.

 

Transactional leaders tend to be more passive and transformational leaders more proactive. While a transactional leader would work within the confines of the organizational culture, the transactional leader would seek to change and improve the culture. Transformational leadership enhances the motivation, morale, and job performance of followers.

Effective Leadership will act as a role model and inspire others to develop and innovate. They would advocate empowerment, encouraging followers to take greater ownership for their work. Transformational leadership has become more important in recent years. The dynamic nature of the environment facing many organisations today means that there is a constant need to innovate and change. It is suggested that to cope with this type of environment, leaders need to have vision and creativity, be innovative and capable of inspiring others.

The distinguishing feature of transformational leadership is the ability to bring about significant change.

In reinforcing the change and establishing tone at the top both in business processes and in people’s mindset, the communication is the KEY. It can be realized through various channels and here we will provide some practical methods on how this can be developed, on the example of VEON Armenia (currently known as “Telecom Armenia”).

The most successful and effective channels are proven to be those, which include a live interaction between the senior leadership and employees of the company. Live discussion is crucial and employees must observe and realize that senior leadership of the company not only demonstrates adherence and follows the requirements of business ethics, but also constantly demonstrates this by a personal example. From our experience, the most effective channels for the establishment of the tone of the top are so called Town Halls[8], that help to emphasize and communicate important topics and compliance related subjects on a highest possible level. To this extent it is crucial to organize sufficient number of Town Halls, at least on a quarterly basis and to include as many important topics as possible. Town halls provide an excellent opportunity to address all the common areas and matters that are currently trending in the Company and across the industry. In Telecom Armenia there is a common practice to invite a member of senior leadership team to be a speaker and to deliver a presentation for the audience. The subject can include themes on Internal Control and risk Management, Government and Regulatory Affairs, Legal and HR related matters. This initiative provides excellent opportunity to address various aspects of the compliance program and to get valuable feedback from the personnel. It is also very important to shift the subject and format of Town Halls constantly, maintain the interest of the people, keep them involved and not to repeat the same approach over and over again. This helps ease the nervousness, anxiety and establish a more informal discussion.

Another channel to set the proper tone, are so called Brown Bag meetings. These are more informal initiatives, conducted by the respective functional division, that do not envisage the participation of Compliance function. The main objective of such approach is to maintain a trust between various levels of leadership and trickle-down the responsibility and authority of ethical culture through the whole organization.

The last but not least important channel for setting up proper tone are of course the regional visits by Senior Leadership. The tone from the top should cover the entire company including its remote regional divisions and not to be restricted to the Headquarters only.

 

Those are of course just a demonstrating examples, and in practice they will highly depend on the size, structure, nature and industry of the organization, however such activities will ensure that senior leadership and employees are aligned on the same level, corporate values are shared, adequately communicated and followed by everyone in the company.

 

Conclusion and takeaways

In today’s ever-changing business world, it is becoming more and more challenging to manage the organizations. Nevertheless, the efforts to implement and maintain an ethical approach in governance may help to ease and overcome the obstacles, faced by modern organizations.

A starting point is of course to set the appropriate tone at the top, that will be the foundation on which the trust, common interests, values and ultimate goals of the organization will be based on.

It is crucial however, to understand what the prevailing culture is first, before attempting to make any wide-sweeping changes, to inform and drive Tone from the Top messages. In doing so, various public resources and corporate codes may be used as benchmarks, including UK Corporate Governance Code[9], OECD Good Practice Guidance, ICGN Global Governance Principles, etc. If the organization already has a good standing in this respect, a careful consideration must be taken, whether it will be justified to reinforce new, fundamental changes and how they might affect the performance and overall environment of the company. In any cases, an appropriate balance should be achieved, whenever possible.

 

Another point that must be recognized in developing the tone, is the overwhelming expansion of social media and mobile technologies. The world is becoming increasingly integrated, and as a result, any improper action or word can instantly go viral, thus undermining the years of efforts to establish an appropriate ethical tone.

After all, as Warren Buffett once said – “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently”.[10]

 


 

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