Magazine article Strategic Finance

TONE AT THE TOP VS. TUNE IN THE MIDDLE: When It Comes to Creating an Organizational Ethical Culture, Who Has the Most Influence-Upper Management or Direct Supervisors?

Magazine article Strategic Finance

TONE AT THE TOP VS. TUNE IN THE MIDDLE: When It Comes to Creating an Organizational Ethical Culture, Who Has the Most Influence-Upper Management or Direct Supervisors?

Article excerpt

In 1987, the National Commission on Fraudulent Financial Reporting (also referred to as the Tread-way Commission) made a number of recommendations it believed would improve the reliability of corporate financial reporting. One of those recommendations was for top management to establish a culture within its organization that encourages transparent and ethical behavior. People commonly refer to this as "tone at the top."

It's natural to focus on upper management and the board of directors when attempting to promote ethical behavior, as it is believed these groups are likely to have the largest impact on the greatest number of employees in an organization. But not all employees have direct interaction with the CEO, CFO, or board of directors. They may hear rumors concerning how upper management behaves or even hear what upper management has to say in meetings or other settings, but they don't experience management's behavior firsthand. Their experience with management is dominated by interactions with immediate supervisors. The behavior of these individuals could have greater influence on employees' approach to ethical behavior. In other words, the "tune in the middle" may be more relevant to their decision making than the tone at the top. In fact, participants in a 2010 study on reducing financial statement fraud conducted by the Center for Audit Quality made the point that a first-line supervisor plays a larger role in influencing a person's ethical judgment than upper management does.

For example, Panasonic Corporation incurred penalties of more than $280 million in 2018 when two executives of a business unit admitted to violating accounting rules without oversight by anyone at the business unit or the parent company. In 2015, a former chief accounting officer of Beazer Homes was sentenced to 10 years in prison after being found guilty of conspiracy and obstruction of justice charges related to a seven-year accounting fraud at the company. While Beazer's CEO and CFO were required under the Sarbanes-Oxley Act to return certain compensation resulting from the accounting fraud, neither were charged with any misconduct. And JPMorgan Chase & Co. was forced to restate a number of U.S. Securities & Exchange Commission (SEC) filings and disclose material internal control weaknesses with respect to the London Whale trading scandal in 2012. A subsequent investigation revealed that lower-level employees who committed and covered up the fraud provided Chase CEO Jamie Dimon and the board of directors inaccurate information as a way to cover up the fraud (see "The Tale of a Whale," Strategic Finance, April 2015, bit.ly/2rWSiPd). In all three of these cases, leaders below the "tone at the top" level committed fraud without apparent knowledge of their superiors.

In 2010, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) analyzed SEC Accounting and Auditing Enforcement Releases (AAERs) issued between 1998 and 2007 and found that, while the CEO or CFO was listed as being involved in 89% of investigated financial statement frauds, controllers were listed in 34% of cases and other vice presidents were listed in 38% of cases (bit.ly/2tNo0yO). Since the analysis focused on the highest-ranking person listed in the AAERs, it's reasonable to conclude that people below the top corporate ranks perpetrated at least some of these financial statement frauds.

The Association of Certified Fraud Examiners (ACFE) Report to the Nations on Occupational Fraud and Abuse: 2018 Global Fraud Study reports that while upper/executive management is the single largest group that committed financial statement fraud, people below those levels committed close to 70% of financial statement frauds. Finally, a 2016 worldwide study by PwC finds that while 98% of survey respondents believed their top management is committed to ethical behavior, only 16% considered their CEO to be the "ethics champion" at their organization (bit. …

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