Ethical Business Practices (EBP) and Corporate Financial Performance(CFP)

An Empirical Analysis

ABSTRACT

Business ethics for long has been considered an oxymoron. The view of Milton Friedman that the sole purpose of business is profit maximization has often been considered an appropriate view. Good ethics are not usually viewed as good for business.

This study helps establish a list of ethical practices which can be used by companies to create an ethical culture. The aim has been to find a correlation between the EBP and the CFP.

The list of EBP was drawn from literature review. The pilot study was conducted across 4 organizations and 40 employees. The final questionnaire with 26 EBP was administered in 10 companies to a total of 120 employees across all levels. The ET 500 list was used as it is a comprehensive list of financially high performing companies across a variety of financial parameters.

For the 26 items which measures EBP, descriptive statistics is generated which includes minimum, maximum, mean, standard deviation. EFA (exploratory factor analysis) and then CFA (confirmatory factor analysis) was conducted on the list of ethical business practices, 3 factors emerged.

The findings are:There is a gap between the mean of the relevance statements and the mean of the extent to which it is practiced in the organization

Correlation between EBP and the 7 financial indicators shows a positive correlation across all the 7 financial indicators. Between EBP and Profit after Tax there is a 72% correlation. It is significant at 0.01 level.

70% of the respondents in the interviews said not adhering to EBP will result in a loss in the long run.

A variety of suggestions for the implementation of EBP in the organizations were also got.

INTRODUCTION

Emergence of Ethics and Ethical Business Practices (EBP):

In India, unethical business became a recognised phenomenon during the Second World War. Academics, journalistic and legal concern with ethics has become visible only during the nineties. In fact until the year 1992, ethics in business was hardly a topic of concerted engagement at any level- except in 2 or 3 business schools in the country. It was only the 2 billion dollar stock exchange fiasco in 1992, the Harshad Mehta scam which threw up the ethics issue at the macro level. [Chakraborty, 1997].Business Ethics is in the forefront since India got its own Enron - The Satyam scandal.As one Shell executive observed ‘we have 300 years of experience with financial accounting, 30 years with environmental accounting and virtually none with social/ethical accounting [Paine, 2003].

Defining Ethical Business Practices:

Most definitions of BE, on the one hand,  relate to ethical standards rules, standards and moral principles regarding what is right or wrong in specific situations. BE comprises the principles and standards that guide behaviour in the world of business[Ferrel, 2008]. EBP then is not just ‘right action’ but is also an on-going effort to develop and strengthen the habit of right action[Gupta, 2006].

For an ethical dilemma presented, 80% of the participants acting in a corporate capacity made a decision that 97% of those acting in a personal capacity judged to be morally unacceptable. This discrepancy suggests how powerfully and subtly corporate roles can influence behaviour [Paine, 2003]. Innumerable companies have spawned mini bureaucracies to administer various special programmes for ethics, diversity, environment and compliance.

The FSG -Federal Sentencing guideline- has motivated almost all large companies to adopt a code of ethics. With regards to environment it looks at positive programmes in place such as pollution reduction, recycling and energy saving measures as well as negative measures such as level of pollutants, EPA (Environmental Protection Agency) citation, fines, law suits and other measures. [Hopkins, 2003]

Not only Community relations, Employee relations, Diversity, Customer relations [Curtis, 1999]. But also, business practices ie diversity- women representation in the workforces are also to be taken into account [Paine, 2003]. EBP now embraces a wide range of corporate responsibilities ranging from working conditions dealing with corruption and fraud, through to environmental and social responsibility [Holt, 2010]. This expansion of terminology is a result of the widening remit of business studies to include social and environmental dimensions alongside the traditional economic concerns [Holt, 2010].

While most companies have basic policies on employee integrity, confidentiality and sexual harassment, relatively few have established policies regarding bribery, exploitive child labour, human rights violations and other issues they may encounter in the global market place [Nader, 2002].

A cut paste action of ethics code is not enough. In practice many organisations try to influence norms and values by formulation and communication of ethical codes[McDonald, 1999]. This together with professional training will not only improve the standards adopted generally by companies but also introduce the necessary level of support from the boardroom to ensure effective implementation in areas which to date is causing many companies some difficulty[Summerfield, 2004].Thus the 7 area framework of ethical practices are 1.1. CSR 2.Diversity 3.General 4.Employees 5.Government 6.Customer 7.Environment [Shantaram, 2010]

The two constructs of Business Ethics as well as Corporate Financial Performance are  intertwined and thus it is relevant to examine the impact of one over the other.

Impact of EBP on CFP

The establishment of the GRI-Global Reporting Initiative gives the minimum standards that companies should meet [Holt, 2010]. Thus this will help companies know if they are on track. So it is important that the organisations first put in place the various ethical practices and ultimately measure it.

Various EBP and their impact on corporate performance are being studied. According to KPMG’s International Survey of Corporate Sustainability Reporting 2002 45% of the Fortune global top 250 companies are now issuing environmental, social or sustainability reports in addition to their financial reports [Norman, 2003].The report of Environics 2001 CSR monitor reported that corporate reputation is now based more on social responsibility than brand image, particularly in wealthy countries. The majority of respondents ranked environmental impacts, labour practices, business ethics and social contributions as the most important factors for forming an impression of the company. Hence it reemphasises the fact that ethical practices needs to be focussed on [Economist, 2001].

The empirical study of Fortune 1000 firms assessed the degree to which the firms have adopted various practices associated with corporate ethics programmes[Weaver, 1999]. Ethics training had a positive effect on behaviour, however very few firms provided such training [McDonald, 1999].

The benefit of implementing EBP in the organisations.BE principles appropriately applied has helped many struggling companies to turn their fortunes around [Gupta, 2006]. However, results show a high degree of corporate adoption of ethics policies, but wide variability in the extent to which these policies are implemented by various supporting structures and managerial activities. In effect, the vast majority of firms have committed to the low cost, possibly symbolic side of ethics management (e.g. adoption of ethics codes and policies etc). But firms differ substantially in their efforts to see that those policies or codes actually are put into practice [Weaver, 1999]. The Chinese business executives report a much stronger belief that positive ethical practices are rewarded with additional sales or revenues in comparison to the US business executives who were on average not nearly as certain [Baglione, 2007].

Making ethical decisions is easy when the facts are clear and the choices black and white. But it is a different story when the situation is clouded by ambiguity, incomplete information, multiple points of view and conflicting responsibilities [Andrews, 2003].Some researchers believe ethical lapses spring from employees putting their own needs above honesty [Kelly, 2002]. As an ethical culture gets built through the establishing of Ethical Business Practices the employee is more likely to make the right choices.However,certain actions taken by organisations fail to produce the desired results. Stock compensation actually increases the likelihood of accounting regularities [Bowie, 2011]

Also there is a strong positive link between a corporation’s performance using threeunrelated published financial and non-financial measures and a public commitment by its management to follow a code of ethical corporate conduct[Verschoor,1999].Unethical conduct by firms which is discovered and publicized does impact on the shareholders by lowering the value of their stock for an appreciable period of time. Whatever their views on whether ethical behaviour is profitable, managers should be able to see a definite connection between unethical behaviour and the worth of their firm's stock. Stockholders, the press and regulators should find this information important in pressing for greater corporate and managerial accountability [Rao et al 1996]. The path to hell is paved with good intentions. Thus if one is not watchful or vigilant, one may take decisions or adopt courses of conduct, which prima facie appear to be good but will ultimately lead to disaster.Corruption is defined by the World Bank as the use of public office for private profit.Corruption is lack of integrity. When we talk of combating corruption really it would mean that the act of corruption has already taken place and we are trying to fight it. This means we are undertaking an exercise of breakdown maintenance.Vigilance really can be connected with the engineering terms of preventive, punitive and predictive maintenance.

EBP sets up norms of functioning that are transparent in every respect. It is transparency that adds to the bottom line on a more enduring basis [Gupta, 2006].

Research Gap:

What are the various EBP, what are their outcomes and how do these relate to CFP ? These and many other questions abound within this research domain.

Does business ethics pay? Is a question some would say is a wrong one. Behaving ethically, they argue, is what you do because it is the right thing to do [Webley 2004].Before answering these questions, understanding what are the various ethical business practices (EBP) was needed to be developed. The literature review resulted in developing the framework of the 7 aspects of EBP. 1. CSR 2.Diversity 3. General  4.Employees 5.Government 6.Customer 7.Environment [Shantaram, 2010]

This was further tested through the pilot study and finally a 26 item questionnaire was developed.

In summary, there is clear evidence of a very strong connection between superior corporate performance and a public statement by corporate management of a strategic reliance on ethics. The link exists for both financial and non-financial criteria. The most critical factors appear to be both the nature of the values upon which the corporate culture is based as well as the strength of the top management commitment to ethical treatment of stakeholders which is expressed in actions and not just in words.[ Verschoor, C. C. 1999]

Based on the challenges of measuring both EBP and the CFB we have been able to establish the need for this study. The ‘morality pays’ argument has proven especially appealing to business ethicists who understandably feel pressure to respond to the economic concerns of shareholders and other stakeholders[Corvino,2006]  What needs to be focused on is both ethics and profitability.

Research Design:

One of the objectives of the study to measure the ethical business practices in corporate India.  With help of literature review, pilot study and expert review 26 variables were identified.  All these variables are exploratory in nature so exploratory factor analysis was done by using PCA extraction. In order to confirm these extracted variables, E/CFA approach is adopted, that is, extracting variables in EFA by using ML estimation, then the number of variables came to 12 and factors were 3.  In order to confirm these, factor structure, loadings relation CFA was done. 

One way anova was used to check for significant difference in perception of Practice and Relevanceto Business Ethicsin the various attributes.

Pearson Correlation between the EBP score and the CFP (7 financial parameters) was done.Cronbach alpha reliability test was done on the questionnaire.

Findings:

1.Cronbach Alpha reliability test was done on the questionnaire of 26 items which gave a reliability score of .861.

2.CFA resulted in the three factors namely:  Factor 1: Company Ethical Policy oriented, Factor 2: Society oriented and Factor 3: Customer oriented. A total of 12 items came under the 3 factors, so in future just the 12 items can be used to understand the ethical practices followed by organisations instead of the 26 items in the list of EBP.

3. Gap analysis was studied comparing the Relevance Mean Score and Practice Mean Score in corporateswhich reflect aclear gap between what is considered relevant to ethics and what is actually practiced in the organisation. The practices need to be increased.

4.The Pearson correlation was done between EBP and the 7 financial parameter/indicators shows a positive correlation across all the 7 financial parameter/indicators. Between EBP and Profit after Tax there is a 72% correlation. It is significant at 0.01 level.

5. The interviews which were done on the respondents parallel to administering the questionnaires indicated that 78% said thatit does not cost the organisation to be ethical.  70% of the respondents in the interviews said not adhering to EBP may improve bottom-line in the short run however will result in a loss in the long run.

A variety of suggestions for the implementation of EBP in the organizations were also got , among them were top management involvement, ethics training and taking strong disciplinary action against unethical behaviour

Table   1 Cronbach Alpha Reliability Test

Reliability Statistics

Cronbach's Alpha

N of Items

.861

26

Table   2 Pearson Correlation

Corporate Financial Performance (CFP) and Ethical Business Practices (EBP)

Correlation between CFP and EBPS

 Corporate Financial Performance (CFP)

Ethical Business Practices Score (EBPS)

Pearson Correlation

Sig. (1-tailed)

Earnings Per Share

31%

0.19

Closing Price of share

11%

0.38

Sales

25%

0.26

Salaries and Wages

42%

0.11

Staff welfare

25%

0.25

Profit After Tax

72%

0.01

Capital Reserves

13%

0.41

** Correlation is significant at the 0.01 level (1-tailed).  (N=10)

References:

  1. Andrews, K.R. Ethics in Practice. Harvard Business Review on Corporate Ethics. HB School Press,USA 2003
  2. Baglione, S, Zimmener, T. Ethics, Values and Leadership Beliefs and Practices: An Empirical study of US and Chinese business executives. 2007, 1/2: 111-125
  3. Bowie, N and Schneider, M. Business Ethics for Dummies, Wiley Publishing Inc.,Indiana 2011
  4. Chakraborty, S. K. Business Ethics In India. Journal of Business Ethics.1997, 16/14: 1529-1538 
  5. Corvino, J. Reframing “Morality pays”: Toward a better answer to “why be moral?” in business. Journal of Business Ethics. 2006,67 (1):1 - 14.
  6. Dr.Curtis C. Corporate Performance is closely linked to a Strong Ethical Commitment. Business and Society Review. 1999, 104/4: 407-415.
  7. Ferrel , Fraedrich & Ferrel. Business Ethics. 7th ed, Houghton Miftlin company, 2008
  8. Gupta, D. Ethics Incorporated. Top priority and Bottom line. 1st ed ,Sage, Delhi India2006.
  9. Holt D, Baskemeyer R and Figge F. A longitudinal and contextual analysis of media representation of Business Ethics. European Business Review.2010, 22/4:377-396
  10. Hopkins, M , The Planetary Bargain: Corporate Social Responsibility matters, 1st ed ,Prentice Hall, Reston ,VA 2003, pg 6
  11. McDonald G., Nijhof A. Beyond Codes of Ethics: An integrated framework for stimulating morally responsible behaviour in organisations. Leadership &Organisation Development Journal. 1999, 20/3: 133-146.
  12. Nader Asgary, Mark C. Mitschow, Toward a Model for International Business Ethics. Journal of Business ethics. 2002, 36: 239-246.
  13. Norman W., MacDonald C. Getting to the Bottom of Triple Bottom-line. Business Ethics Quarterly. 2003, 14/2: 243-262.
  14. Paine L. S. Value Shift 1st ed. Tata McGraw Hill, New York, USA. 2003, 11-136
  15. Rao, Spuma M. & Hamilton, J. Brooke (1996). The effect of published reports of unethical conduct on stock prices. Journal of Business Ethics 15 (12):1321 - 1330.
  16. Sekhar,R.C ,Ethical Choices in Business, 2nd edition,New Delhi 2002: 54,55
  17. Shantaram, A (2010) , Ethical Practices in organisations: Developing the list of ethical practices and checking for their relevance and its practice in organisations. Myths and Realities India Advantage. SIMSARC 10: 142-149
  18. Summerfield D. Corporate Governance: the stakeholder debate. Business Ethics: Facing up to the issues 1st ed. Economist Publication, London.2004, 91-100.
  19. Verschoor, C. C. (1999), Corporate Performance Is Closely Linked to a Strong Ethical Commitment. Business and Society Review, 104: 407–415.
  20. Weaver G.R., Trevino L., Cochran P. Corporate Ethics Practices in the Mid 1990’s: An Empirical Study of the fortune 1000. Journal of Business Ethics. 1999, 18/3: 283-294.
  21. Webley ,S. More, E. Does Business Ethics Pay? Ethics and Financial Performance, 1st ed Institute of Business Ethics , London ,2004 pp 47
  22. The ethics of Corporate Social Responsibility Management trend of the New Millennium? Economist, 1/ V: 17 2001, 13-33

Appendix:

Section II Relevance to Ethics and Practice of Ethics activities in your organization

Please note the 1st column asks you to rate how relevant to ethics you find each statement.

The 2nd column asks you to rate to what extent the statement reflects what is practiced in your organisation.

St#

Statements

Highly Relevant

 

NN

 

Least Relevant

 

Strongly Agree

 

NN

 

Strongly Disagree

q1

The organisation spends a significant percentage of the profit on social development  activities

5

4

3

2

1

 

5

4

3

2

1

q2

The organisation has a well thought out CSR policy just not charity and donations.

5

4

3

2

1

 

5

4

3

2

1

q3

CSR is based on the urgent needs of the communities it works in.

5

4

3

2

1

 

5

4

3

2

1

q4

It  volunteers employee hours towards social projects

5

4

3

2

1

 

5

4

3

2

1

q5

It has a significant minority representation across the employees level

5

4

3

2

1

 

5

4

3

2

1

q6

It has a fair level of Women representation on the companies roll

5

4

3

2

1

 

5

4

3

2

1

q7

It has number of Independent directors  as  per SEBI guidelines

5

4

3

2

1

 

5

4

3

2

1

q8

It has a clearly laid out ethics code

5

4

3

2

1

 

5

4

3

2

1

q9

It enforces ethics training across its employees

5

4

3

2

1

 

5

4

3

2

1

q10

There is a specially designated Ethics officer

5

4

3

2

1

 

5

4

3

2

1

q11

Ethics hotline ( reporting misconduct over phone or mail) is functional and accessible to all employees.

5

4

3

2

1

 

5

4

3

2

1

q12

It enforces Code of conduct for outsourced companies.

5

4

3

2

1

 

5

4

3

2

1

q13

Code for punishment of sexual harassment is clearly designed and communicated to all employees.

5

4

3

2

1

 

5

4

3

2

1

 

q14

Company  is a member of  associations which deals with ethics  , corporate governance  even though it is not mandatory (eg. global compact, transparency international, etc)

5

4

3

2

1

 

5

4

3

2

1

q15

There is fair opportunities in promotion and reward systems

5

4

3

2

1

 

5

4

3

2

1

q16

The company ensures good and safe  working conditions for the employees

5

4

3

2

1

 

5

4

3

2

1

q17

It ensures timely payment of salaries

5

4

3

2

1

 

5

4

3

2

1

q18

It ensures timely payment to vendors

5

4

3

2

1

 

5

4

3

2

1

q19

It ensures timely payment of taxes etc. (no fines levied)

5

4

3

2

1

 

5

4

3

2

1

q20

The organization is  concerned  about  the  energy efficiency ( uses LED lights, water conservation etc)

5

4

3

2

1

 

5

4

3

2

1

q21

The organization practices  waste management  (e-waste,  water recycling etc)

5

4

3

2

1

 

5

4

3

2

1

q22

It follows Triple bottom line  (social, financial and environmental  accounting in the balance sheet) and not just financial indicators

5

4

3

2

1

 

5

4

3

2

1

q23

The company provides complete information about their  products and services to the customers

5

4

3

2

1

 

5

4

3

2

1

q24

It maintains  customer information confidential

5

4

3

2

1

 

5

4

3

2

1

q25

Company ensures that the  promises made to  customers are fulfilled  (delivery, services and after sales services)

5

4

3

2

1

 

5

4

3

2

1

q26

It follows the corporate governance voluntary guidelines

5

4

3

2

1

 

5

4

3

2

1