It's well accepted that the CEO is the most important element to setting a company's ethics and compliance tone. At most companies the board of directors pays close attention to integrity and ethical values when considering candidates for the position, and in measuring the CEO's performance.
But here's a vital question: “How do we really know whether an individual is truly honest and ethical?” The short answer is that in many cases we just don't. We've seen a number of companies oust their tarnished chief executives and scramble to quickly find a replacement—including Best Buy, Boeing, and Hewlett-Packard, among others—after they used questionable judgment, causing upheaval and associated pain and reputational damage.
Knowing what traits and habits can be indicators of a potential for improper or unlawful action can help. Sure, there are no absolutely clear, readily apparent traits that can determine with certainty whether a person will act with integrity and ethical values, but there are signs that should be of interest. A recent study, Executives' ‘Off-the-Job' Behavior, Corporate Culture and Financial Reporting Risk, for example by professors from Georgetown, the University of Minnesota, and the University of Chicago found some interesting correlations between executives' past histories and potential to commit fraud.
CEOs of companies that committed fraud are more likely to have had felony drug charges, domestic violence, and serious traffic violations. Even one speeding ticket correlates with a seven times greater likelihood of engineering an accounting fraud.
“Unfrugal” CEOs—as measured by relative values of their homes, boats, and cars—are more likely to head companies where others commit fraud or the company is forced to restate its financial statements. These CEOs are viewed as overseeing a relatively lose control environment characterized by such outcomes.
Cultural changes associated with increased fraud risk are more likely during an unfrugal CEO's reign, including appointment of a CFO with similar personal assets, an increase in executives' equity-based incentives to misreport, and a decline in measures of board monitoring intensity, including change in composition and compensation of the board.
Does this mean CEOs who drive their Ferraris fast will be associated with fraud? Of course not. Many CEOs live very well and have one or more speeding ticket to their name.
So what traits should directors, investors, and others look for? Part of the answer is based on experience and instinct, where seasoned business executives, venture capitalists, audit executives, consultants, or others can walk into a company's offices and spend time with the chief executive and quickly get a sense of their personality—including whether the CEO's tone is one of excessive risk-taking, arrogance, stretching the rules, or otherwise. This certainly is not foolproof, and further contact may dispel first impressions, but often what initially appears is indeed the reality.
Certainly, different management styles drive success, often with a fine line between being able to get personnel on board with strategy and related implementation through strong leadership, versus bullying and intimidation.
Experience shows that arrogance is a particularly telling factor. A few years ago I met with a high-profile CEO of a major company, one with a great track record of innovation, growth, market share, and profitability. In the first five minutes of meeting the CEO, I encountered arrogance to the point of outright bullying. This was a man so confident in himself and his power that when he said “jump” he was certain everyone around him would ask “how high.” The CEO's behavior was so ingrained that he didn't seem to consider that as part of my engagement I would write a report to regulators critiquing the company's governance processes, including his role in them.
Now, a few years later, this once fine company is struggling, with analysts saying it might not survive long term. Certainly, different management styles drive success, often with a fine line between being able to get personnel on board with strategy and related implementation through strong leadership, versus bullying and intimidation. There's no doubt that other factors were at play in this company's decline besides the CEO's behavior—but there appears to be at least a relationship.
It's certainly challenging to get inside the heads of CEOs to learn what personality factors signal higher risk for integrity issues, but that doesn't mean it's impossible. Some years ago, I led a study of underlying causes of fraudulent financial reporting, which involved examining fraud cases and working with a noted business school professor who is a licensed psychiatrist. A prime objective was to identify CEO characteristics that signal a greater likelihood of financial statement mis-statement, including dishonesty with the audit engagement team to effect desired reporting outcomes or otherwise hide fraudulent financial reporting. The findings pointed to such traits as arrogance, bullying, and other factors related to the imperial CEO syndrome.
We also can point to another all-too-human trait—namely greed. One wonders, for example, why Rajat Gupta, the highly regarded former McKinsey & Co. CEO and more recently director of Goldman Sachs, Proctor & Gamble, and other major companies, would do what he did to result in conviction on insider trading. Observers suggest that despite his $100 million net worth, he felt left out of the “billion dollar club” and wanted in. Prosecutors also referred to an “above-the-law arrogance.”
We know that when a highly placed corporate official acts badly, it's not only the act itself but also the cover up. There are many examples, including Mark Hurd, CEO of Hewlett Packard. Why did he engage in behavior that led to sexual harassment charges, and then in explaining the matter to the H-P board cause directors to view his disclosures as less than honest? Yes, his initial judgment and decision making was suspect, but it seems the matter of integrity became more significant in determining his corporate fate.
There's a sense that when a person shows poor judgment on an ethical matter it calls into question how that individual can be expected to act going forward. In the examples cited earlier, the CEOs of Best Buy, and Boeing, as well as the incoming CEO of Lockheed, each reportedly had relationships with female employees that caused the board of directors to question these CEOs' judgment and resulted in their corporate demise.
Yes, the behavior and demonstrated mindset of CEOs provide signals of what to expect in future performance of the individual and the company. Correlations might not prove cause and effect, so we don't know whether speeding tickets or where people live necessarily are indicators of integrity.
Boards of directors looking at candidates or evaluating CEO performance should be positioned to know the individual well enough to have a good sense of how he or she will behave and perform. This is a critical element of what is perhaps the board's most important responsibility—and critical warning signs must not be ignored, but rather carefully considered and acted on.
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