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CHAPTER 9
Managing and Controlling Ethics Programs
SUMMARY
This chapter examines the concept of an ethics audit as a way to help implement an effective ethics
program. The chapter begins by discussing the implementation of ethics programs. We define the term
ethics audit and explore its relationship to a social audit. Next, we examine the benefits and limitations
of this implementation tool. The challenges of measuring nonfinancial ethical performance are
examined, and evolving standards are reviewed from ISO 19600 and the Open Compliance Ethics
Group. We then detail a framework for an ethics audit, including securing the commitment of directors
and top managers; establishing a committee to oversee the audit; defining the scope of the audit
process; reviewing the firm’s mission, values, goals, and policies and defining ethical priorities;
collecting and analyzing relevant information; verifying the results; and reporting them. Finally, this
chapter considers the strategic importance of ethics auditing.
INSTRUCTOR NOTES FOR “AN ETHICAL DILEMMA”
Mei-li has been placed in a difficult position by her coworker and boss. Mei-li is a consultant with
Business Equipment Corporation (BEC) and is working with Kyle, an engineer, to develop and produce
a new copy machine with greatly improved technology. However, a competitor of BEC, Hiyota, is
about to release a new copy machine that may be as good as their product, if not better. Kyle has told
Mei-li to pretend to be a potential customer, call Hiyota to set up an appointment to meet with a
salesperson, and learn about their copy quality, novel product features, pricing, and advertising strategy
so that BEC can modify their machine and defeat Hiyota. Mei-li is not comfortable pretending to be a
buyer and believes this would be a violation of BEC’s code of ethics, specifically the company’s strong
commitment toward competing fairly and honestly. Kyle tells Mei-li this is not illegal and that behavior
such as this takes place all the time. Mei-li asks their boss, Bob, about Kyle’s proposal. Bob tells Mei-li
unofficially to follow Kyle’s plan, but officially that BEC does not condone such practices. When
Mei-li asks Bob if he has ever done something like this before, Bob responds with a list of excuses he
has heard to justify such unethical behavior and does not directly answer Mei-li’s question.
Mei-li is being pressured to violate BEC’s code of ethics by both Kyle and Bob. Mei-li is aware that
Kyle is under great pressure to make sure BEC’s machine out-performs Hiyota or he will probably be
fired. Ask the students if they believe Kyle’s plan would violate BEC’s code of ethics? Discuss the
questionable way in which Bob responded to Mei-li’s questions. Does Kyle’s possible termination
justify Mei-li following Kyle’s plan? How should Mei-li handle the situation?
48 Chapter 9: Implementing and Auditing Ethics Programs
LECTURE OUTLINE
I. Implementing an Ethics Program
A. In order to implement a successful ethics program, an organization must have ways of
managing, evaluating, and controlling business ethics programs.
B. Viewing a business ethics program as a part of strategic planning and management activities
is critical to the success of any firm.
1. Five items have a significant impact on whether an ethics program is successful:
a. the content of a company’s code of ethics
b. the frequency of communication regarding the ethical code and program
c. the quality of communication
d. senior management’s ability to successfully incorporate ethics into the
organization
e. local management’s ability to do the same.
2. Shared values among employees are the “glue” of successful management and control
of business ethics programs. When the business ethics program helps to align and
direct activities toward an ethical culture, there will be a commitment to the long-term
ethical progress of the firm.
C. Three types of controls are involved with implementing and managing an ethics program.
1. Formal controls for business ethics include input controls that provide the proper
tools and resources (proper selection of employees, ethics training, and structural
systems, including communication systems).
2. Process controls include management’s commitment to the ethics program and the
methods or system for evaluation.
3. Output controls involve setting standards against actual behavior. One of the most
popular methods of evaluating ethical performance is an ethics audit.
II. The Ethics Audit
A. An ethics audit is a systematic evaluation of an organization’s ethics program and
performance to determine whether it is effective.
B. It includes regular, complete, and documented measurements of compliance, measuring
conformity to the firm’s desired ethical standards.
C. Can be a precursor to setting up an ethics program. It identifies the firm’s current ethical
standards, policies, and risk areas so that an ethics program can effectively address problem
areas.
D. A social audit is the process of assessing and reporting a business’s performance in fulfilling
the economic, legal, ethical, and philanthropic responsibilities expected of it by its
stakeholders.
1. Social reports often discuss issues related to a firm’s performance in the four
dimensions of social responsibility as well as to specific social responsibility and
ethical issues such as staff issues, community economic development, volunteerism,
and environmental impact.
2. In contrast, ethics audits focus on more narrow issues related to assessing and reporting
on a firm’s performance in terms of ethical and legal conduct.
Chapter 9: Implementing and Auditing Ethics Programs 49
3. An ethics audit can be a component of a social audit. Ethics auditing is similar to
financial auditing in that it employs similar procedures and processes to create a
system of integrity that includes objective reporting.
III. Benefits of Ethics Auditing
A. There are many reasons why companies choose to understand, report on, and improve their
ethical conduct.
1. One reason is to detect ethical misconduct before it becomes a major problem.
2. Accounting scandals and legal and ethical transgressions have encouraged companies
to better account for their actions in a wide range of areas including corporate
governance, ethics programs, customer relationships, employee relations,
environmental policies, and community involvement.
3. Measuring the ethical work climate is one way to learn about the ethical culture of an
organization. The auditing process can highlight trends, improve organizational
learning, and facilitate communication and working relationships
B. One of the greatest benefits of the auditing process is improved relationships with
stakeholders.
1. A greater number of investors are considering nonfinancial measures—such as the
existence of ethics programs, legal compliance, board diversity and independence, and
other corporate governance issues like CEO compensation—when they analyze the
quality of current and potential investments.
2. Regular audits permit shareholders and investors to judge whether a firm is achieving
the goals it established, and whether it abides by the values that it specified as
important.
C. Ethical Crisis Management and Recovery
1. Just as companies develop crisis management plans to prepare to, respond to, and
recover from natural disasters, they should also prepare for ethical disasters, which can
result in substantial legal and financial costs, disrupt operations, reduce productivity,
destroy organizational reputation, and erode stakeholder confidence.
a. Ethical disasters follow recognizable phases of escalation, from ethical-issue
recognition and the decision to act unethically to the organization’s discovery of
and response to the act.
i) Anticipation of and intervention during these situations can stave off
organizational disaster. Contingency planning assesses risks, plans for these
potential occurrences, and provides ready tools for responding to ethical
crises.
ii) The process of ethical disaster recovery planning involves assessing the
organization’s values, developing an ethics program, performing an ethics
audit, and developing contingency plans for potential ethical disasters.
iii) Unfortunately, ethical risks are often given the lowest priority.
D. Measuring Nonfinancial Ethical Performance
1. Although much of the regulatory focus of corporate ethics and compliance is driven by
financial measures, to have integrity, the organization also has to focus on nonfinancial
areas of performance.
50 Chapter 9: Implementing and Auditing Ethics Programs
2. The word integrity implies a balanced organization that not only makes ethical
financial decisions but is also ethical in the more subjective aspects of its corporate
culture.
a. The Sarbanes–Oxley Act has focused on questionable accounting and the metrics
that destroy shareholder value. On the other hand, models exist (Six Sigma, the
Balanced Scorecard, and the Triple Bottom Line) to capture structural and
behavioral organizational ethical performance.
b. Six Sigma is a methodology to manage process variations that cause defects,
defined as unacceptable deviation from the mean or target, and to systematically
work toward managing variation to eliminate those defects.
c. Balanced Scorecard is a management system that focuses on all of the elements
that contribute to organizational performance and success, including financial,
customer, market, and internal processes.
d. The triple bottom line captures an expanded spectrum of values and criteria for
measuring organizational (and societal) success—economic, environmental, and
social impacts of decisions made within the organization.
3. The purpose of nonfinancial measures is to determine the wholeness and soundness of
the many aspects of a business that enhance ethics and profits without increasing risk.
4. The Global Reporting Initiative (GRI), which advances sustainability reporting, has
become a prominent framework that companies have adopted to report their social and
sustainability progress.
a. Businesses can use the GRI to come up with a more standardized method of
reporting nonfinancial results in a way that users of the reports can understand.
b. Companies benefit because the GRI provides tools for improving their
implementation of the triple bottom line, the disclosure of their progress in this
area, the ability to compare their sustainability efforts to those of other
companies, and the chance to enhance their reputation in the eyes of stakeholders.
c. Users benefit because this standardized sustainability reporting provides them
with a benchmark to compare companies’ sustainability initiatives.
5. ISO 19600 provides international guidelines for compliance management.
a. ISO 19600 was based on an Australian compliance standard and emphasizes a
“principles” approach to compliance management based upon commitment,
implementation, monitoring and measuring, and continual improvement.
b. A key part of ISO 19600 is the adoption of compliance objectives and the
assignment of accountability throughout the entire organization.
6. Open Compliance Ethics Group created a universal framework for compliance and
ethics management.
a. Focus on nonfinancial compliance and qualitative elements of internal controls.
b. Guidelines that companies can utilize as they see fit.
c. Offers tools and certification procedures.
E. Risks and Requirements in Ethics Auditing
1. Although ethics audits provide many benefits for individual companies and their
stakeholders, they do have the potential to create risks.
a. A firm may uncover a serious ethical problem that it would prefer not to disclose
until it can remedy the situation.
Chapter 9: Implementing and Auditing Ethics Programs 51
b. It may find that one or more of its stakeholders’ criticisms cannot be dismissed or
easily addressed.
c. The process of conducting an ethics audit may foster stakeholder dissatisfaction.
d. The auditing process imposes burdens (especially with regard to record keeping)
and costs for firms that undertake it.
e. The process of auditing and reporting a firm’s ethics programs is no guarantee
that it will avoid challenges related to its efforts.
f. Because this type of auditing is relatively new, there are few common standards
to judge disclosure and effectiveness or to make comparisons.
2. Being viewed by the public as needing an audit can motivate companies to conduct one
in order to signal their intention to respond to concerns.
3. Although ethics and social responsibility are defined and perceived differently by
various stakeholders, a core of minimum standards for ethical performance is evolving.
a. These standards represent a fundamental step in the development of minimum
ethics requirements that are specific, measurable, achievable, and meaningful
measurements in terms of business impact on communities, employees,
consumers, the environment, and economic systems
b. The FSGO’s seven steps for effective ethical compliance, the Sarbanes–Oxley
Act, and the Dodd-Frank Act provide standards that organizations can use in
ethics auditing.
IV. The Auditing Process
A. Questions to be addressed during an audit:
1. How broad the audit should be
2. What standards of performance should be applied?
3. How often the audit should be conducted?
4. Whether and how the audit’s results should be reported to stakeholders
5. What actions should be taken in response to audit results?
B. An ethics audit should be unique to each company, reflecting its size, industry, corporate
culture, and identified risks as well as the regulatory environment in which it operates.
C. The framework in this text encompasses a wide range of business responsibilities and
relationships. There is no generic approach that will satisfy every firm’s circumstances.
D. Secure Commitment of Top Managers and Board of Directors
1. The first step in conducting the audit is to secure the commitment of the firm’s top
management and, if it is a public corporation, its board of directors.
a. Pressure for an ethics audit may come from the board of directors in response to
stakeholder concerns or legally mandated corporate governance reforms related
to the Sarbanes–Oxley Act, which suggests that boards of directors should
provide oversight for all auditing activities.
b. Court decisions related to the FSGO hold board members responsible for the
ethical and legal compliance programs of the firms they oversee.
2. Pressure for an audit may come from top managers looking for ways to track and
improve ethical performance, and to give their firm an advantage over competitors that
are facing questions about their ethical conduct.
52 Chapter 9: Implementing and Auditing Ethics Programs
3. CEOs and CFOs may face prosecution if they knowingly certify misleading financial
statements.
a. Some companies have established an ethics officer in conjunction with an ethics
program, and the ethics officer may campaign for an ethics audit as a way to
measure the effectiveness of the firm’s ethics program.
b. Regardless of where the impetus for an audit comes from, its success hinges on
the support of top management.
E. Establish a Committee to Oversee the Ethics Audit
1. The next step is to establish a committee or team to oversee the audit process.
a. Ideally, the board of directors’ financial audit committee should oversee the ethics
audit.
b. In most firms, managers or ethics officers conduct social and ethics auditing.
c. This team should include members who are knowledgeable about the nature and
role of ethics audits and come from various departments within the firm.
d. Outside consultants may be hired to coordinate the audit and report the results
directly to the board of directors.
i) An external auditor should not have other consulting or conflict-of-interest
relationships with top managers or board members.
F. Define the Scope of the Audit Process
1. The ethics audit committee should establish the scope of the audit and monitor its
progress to ensure that it stays on track.
a. The scope depends on the type of business, the risks faced by the firm, and
available opportunities to manage ethics.
b. This step includes defining the key subject matter or risk areas that are important
to the ethics audit as well as the bases on which they should be assessed.
G. Review Organizational Mission, Values, Goals, and Policies, and Define Ethical Priorities
1. The audit process should include a review of the current mission statement and
strategic objectives. The company’s overall mission may incorporate ethics objectives,
but these may also be found in separate documents, including those that focus on social
responsibility.
2. This step should examine all formal documents that make explicit commitments with
regard to ethical, legal, or social responsibility, as well as less formal documents,
including marketing materials, workplace policies, and ethics policies and standards
for suppliers or vendors.
3. It is important to examine all of the firm’s policies and practices for the specific areas
covered by the audit.
a. It should look at how managers are rewarded for meeting their goals and the
systems available for employees to give and receive feedback.
b. An effective ethics audit should review all systems and assess their strengths and
weaknesses.
4. Concurrent with this step in the auditing process, the firm should define its ethical
priorities.
Chapter 9: Implementing and Auditing Ethics Programs 53
a. Because there may be no legal requirements for ethical priorities, it is up to
management’s strategic planning processes to determine appropriate standards,
principles, duties, and required action to deal with ethics issues.
H. Collect and Analyze Relevant Information
1. The next step is to identify the tools or methods for measuring the firm’s progress in
improving employees’ ethical decisions and conduct. The firm should collect relevant
information for each designated subject matter area.
a. A thorough audit will include a review of all relevant reports, including external
documents sent to government agencies and other parties. The information
collected will help determine baseline levels of compliance as well as the internal
and external expectations of the company. This step identifies where the company
has met its commitments.
b. Some techniques for collecting evidence might involve examining both internal
and external documents, observing the data-collection process (such as by
consulting with stakeholders), and confirming information in the organization’s
accounting records. Auditors may also employ ratio analysis of relevant
indicators to identify any inconsistencies or unexpected patterns.
2. Because stakeholder integration is so crucial to the ethics audit, a company’s
stakeholders need to be defined and interviewed during the data-collection stage
a. Understanding employee issues is vital to a successful audit.
b. Customers are a primary stakeholder group because their patronage and loyalty
determines the company’s financial success. Providing meaningful feedback is
critical for creating and maintaining customer satisfaction.
3. Some investors seek to include in their investment portfolios the stocks of companies
that conduct ethics and social audits. They are becoming more aware of the financial
benefits that can stem from socially responsible management systems.
4. Organizations can obtain feedback from stakeholders through standardized surveys,
interviews, and focus groups. Companies can also encourage stakeholder exchanges by
inviting specific groups together for discussions.
a. The primary objective is to generate a variety of opinions about how the company
is perceived and whether it is fulfilling stakeholders’ expectations.
5. Once these data have been collected, the firm should then compare its internal
perceptions to those discovered during the stakeholder assessment stage, and then
summarize findings and draw preliminary conclusions.
a. It may involve descriptive assessments of the findings (the costs and benefits of
the company’s ethics program, the strengths and weaknesses of the firm’s policies
and practices, feedback from stakeholders, and issues that should be addressed in
future audits).
b. It may be appropriate to weigh the findings against standards identified earlier,
both quantitatively and qualitatively.
c. Data analysis should also include an examination of how other organizations in
the industry are performing in the designated subject areas.
I. Verify the Results
54 Chapter 9: Implementing and Auditing Ethics Programs
1. The next step is to have an independent party (social/ethics audit consultant, a financial
accounting firm that offers social auditing services, or a nonprofit special-interest
group with auditing experience) verify the results of the data analysis.
2. Verification is an independent assessment of the quality, accuracy, and completeness of
a company’s social report.
a. Independent verification offers a measure of assurance that the company has
reported its audit fairly and honestly, as well as providing an assessment of its
social and environmental reporting systems.
b. Verification by an independent party gives stakeholders confidence in a
company’s ethics or social audit and lends the audit report credibility and
objectivity.
3. An increasing number of companies are opting for independent verification of ethics
audits.
a. The process of verifying the results of an audit should involve standard
procedures that control the reliability and validity of the information.
b. Auditors can apply substantive tests to detect material misstatements in the audit
data and analysis.
c. A financial auditor may be asked to provide a letter to the company’s board of
directors and senior managers that highlights any inconsistencies in the reporting
process.
J. Report the Findings
1. The final step is to issue the ethics audit report.
a. Reporting the audit findings to the relevant internal parties and, if approved, to
external stakeholders in a formal report.
2. The report should spell out the purpose and scope of the audit, the methods used in the
audit process (evidence gathering and evaluation), the role of the (preferably
independent) auditor, any auditing guidelines followed by the auditor, and any
reporting guidelines followed by the company.
3. Although the ethics audit may be similar to a financial audit, their forms are quite
different. In a financial audit, the Statement of Auditing Standards dictates the content
and placement of every word of a financial audit report.
a. The report issued can be an unqualified opinion, a qualified opinion, an adverse
opinion, or a disclaimer of opinion.
V. The Strategic Importance of Ethics Auditing
A. Although the concept of auditing implies an official examination of ethical performance,
many organizations audit their performance informally.
B. Any attempt to verify outcomes and to compare them with standards can be considered an
auditing activity.
C. Organizations such as the Better Business Bureau (BBB) provide awards and assessment
tools to help any organization evaluate its ethical performance. Companies with fewer
resources may wish to use the judging criteria from the BBB’s Torch Award Criteria for
Ethical Companies as benchmarks for their informal self-audits.
Chapter 9: Implementing and Auditing Ethics Programs 55
D. The ethics audit should be conducted regularly rather than in response to problems or
questions about a firm’s priorities and conduct.
E. An audit may be comprehensive and encompass all of the ethics and social responsibility
areas of a business, or it can focus on one or two specific areas.
F. Ethics audits can present several problems.
1. They can be expensive and time consuming
2. Selecting the auditors may be difficult if objective, qualified personnel are not
available
3. Employees sometimes fear comprehensive evaluations, and in such cases, ethics audits
can be disruptive
G. Auditing ethical performance can also generate many benefits.
1. It provides an assessment of a company’s ethical performance as compared to its core
values, ethics policy, internal operating practices, management systems, and the
expectations of key stakeholders
2. The assessment can be used to reallocate resources and activities as well as focus on
new opportunities.
3. The process can also help companies fulfill their mission statements in ways that boost
profits and reduce risks.
4. It can pinpoint areas where improving operating practices can improve both
bottom-line profits and stakeholder relationships
5. It can demonstrate the positive impact of ethical conduct and social responsibility
initiatives on the firm’s bottom line, convincing managers—and other primary
stakeholders—of the value of more ethical and socially responsible business practices.
DEBATE ISSUE: TAKE A STAND
Have your students split into two teams. One team will argue for the first point, and the other will argue
for the opposing view. The purpose is to get students to realize that there are no easy answers to many
of these issues. This debate asks students to choose which ethical auditing guidelines to use for a small
company’s situation. Those arguing for the Better Business Bureau auditing criteria might point out that
this audit provides a practical approach and allows the organization to examine itself from a multitude
of stakeholder perspectives. Those arguing for the audit guidelines provided in Table 9-5 could argue
that it is easier and more helpful to use a checklist of items that address specific areas of the company.
“RESOLVING ETHICAL BUSINESS CHALLENGES” NOTES
In this vignette, Charles has been instructed by the CEO of Butterfly Corporation, Doug, to take
shortcuts in conducting an ethics audit. Doug wants the ethics audit finished quickly and for Charles to
make sure the company looks good. After working for Butterfly Corporation for two years, Charles is
excited to research and prepare a thorough plan for conducting the ethics audit. Unfortunately, it
appears Doug views the board’s requested audit as a formality and does not support its need.
Ask the students if the ethics audit will have a chance to be successful without the support of top
management. The options left to Charles are to either simplify the audit by not using other employees
56 Chapter 9: Implementing and Auditing Ethics Programs
and external parties as requested by Doug or risk the ire of the CEO. Ask the students what they would
do if they were Charles.
