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Oct 17, 1997

Ethics is a Key Factor in Financial Performance, According to Review of Largest U.S. Corporations

But DePaul Study Concludes That An Ethics Policy Is Not Enough; Policy Enforcement Is Necessary To Reap The Profits Of Ethical Behavior

Companies committed to ethical business practices do better financially and have significantly greater representation among the top 100 financial performers than companies which do not make ethics a key component of their overall management, according to a DePaul University professor's study reported in the October issue of Management Accounting magazine.

In fact, the study found that companies committed to ethics are listed among the top 100 twice as often as those without an ethics focus.

Yet the review of the 500 largest publicly held corporations in the United States concludes that merely having a company ethics policy is not enough. A company must also have a strong internal program to enforce its ethics policy in order to reap the financial benefits which usually result.

"Texaco is a great example of why enforcement is key," said Curtis C. Verschoor, author of the study and Ledger & Quill Research Professor in the School of Accountancy at DePaul University in Chicago.

"Though the company said it had an ethics policy, it did not enforce that policy internally throughout the company," he said. "Recent events prove how dangerous and expensive such lack of enforcement can be."

Interest in corporate ethics has increased due to several factors:

  • Under the Federal Sentencing Guidelines, passed in 1991, companies found guilty of legal violations face heavier fines if they do not have a formal ethics program in place.
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  • Special interest groups have grown more vocal about environmental issues and working conditions in the Third World.
  • More than 75% of consumers claim that they would switch brands and retailers to support a worthy cause.
  • One in 10 investment dollars is placed with some ethical or social criterion in mind. As a result, investment assets managed with social or ethical screens amount to nearly $200 billion.
  • Yet ethics programs have become standard operating procedure in only the biggest companies. A study by the Conference Board found that 84 percent of the 500 largest U.S. corporations have a formal ethics program. But a survey of smaller companies, conducted by the Controllers Council of the Institute of Management Accountants found that only about 50 percent of U.S. corporations have an ethics policy.

    While Verschoor concluded that internal controls to enforce the ethics policy are a critical link between ethics and profits, the IMA's Controllers Council survey found that only 20 percent of the companies surveyed have training programs on corporate ethics in place.

    "This connection between ethics, financial performance and profits should become a guiding principle of corporate governance," Verschoor says. "If a corporation's primary commitment is to its shareholders, then companies should implement effective ethics programs which can be crucial to positive financial performance."

    "And as companies improve efficiency, additional ethics-related control issues are developing. When hierarchies are flattened to foster decision making throughout a downsized company, a program must be put in place to ensure the company's ethics policies are fully understood and followed at every level in the organization," he said.

    As reported in Management Accounting, Verschoor analyzed the annual reports of the 500 largest publicly held U.S. corporations by sales or revenues and divided them into three groups: 127 with no management report; 247 with a management report but no mention of ethics; and 126 which specifically discuss a code of conduct or ethics program in their internal control system.

    To determine if the 126 companies which expressed a strong commitment to ethics differed in performance from the other 374 which did not, Dr. Verschoor analyzed how many were included in Business Week's 1997 ranking of corporate financial performance and Fortune's 1997 listing of America's Most Admired Companies.

    The Business Week list ranked companies according to the following financial measures--total return; sales growth; profit growth; net margin and return on equity. The Fortune survey ranked companies according to eight attributes, three of which are financial--long-term investment, financial soundness and use of corporate assets. (more)

    Of the 126 companies with a strong commitment to ethics, 33 (26 percent) were in the top 100. Of the 374 companies which did not emphasize ethics, only 50 (13 percent) made it into the ranks of the top 100.

    Of the ten highest ranking companies on the Fortune most admired list, five were in Professor Verschoor's group of 126 ethics-based companies; only three were in his group of 374 firms which did not focus on ethics.

    Management Accounting is published by the Institute of Management Accountants, the world's largest organization dedicated to management accounting and financial management, with 80,000 members.

    Verschoor can be reached at (312) 362-6903 or e-mail him at cverscho@condor.depaul.edu .