Literature Review - Corporate Governance and Business Ethics

Rewards and Punishments

In essence, constraints can be distinguished with regard to their valence. Rewards set positive incentives in order to make code compliance more attractive for the code addressees. On the contrary, punishments are disciplinary measures which make code deviance more costly and hence less attractive for employees. Many business ethicists state that code conformity can be improved neither by rewards nor by punishments.

Rewards which are not supplementary but intend to be an all-embracing measure for code implementation are indeed inappropriate because codes contain norms, the obedience to which is mandatory rather than voluntary within the company. Obeying the code norms for doing the right thing is one of the duties an employee assumes when entering the respective company. However, people are not used to getting or receiving rewards for doing what is right and for fulfilling one’s duties (Trevino 1990; Trevino and Youngblood 1990; Weaver and Trevino 2001). Based on interviews with (57) employees, managers and ethics officers in Canada, Schwartz (2004) confirms this view because most of his respondents “believed that compliance or doing the right thing is already part of your job for which you are being compensated, and therefore need not be explicitly rewarded in any sense”.

Therefore, rewarding code conformance could lead astray to the awkward impression that code deviance is left to the actor’s discretion because lack of compliance seems to be compensated by waiving of the rewards which are announced otherwise. Rewards generally imply that norm obedience is optional rather than obligatory (Schwartz and Orleans 1967). As Kaptein (1998) puts it:

If a corporation rewards moral conduct too much, it may create the impression that morally responsible conduct is not mandatory. A reward is given for extra performance, which implies that such extra performance is not mandatory.

Thus, the abiding ness of the code norms becomes relative to the rewards announced for code compliance. Therefore, code norms tend to be violated if deviance cannot be observed and hence cannot jeopardize the compensation.

Against this background, constraints-based measures for code implementation have to rely predominantly on punishments, i.e., negative sanctions in reaction on code violations. However, many criticisms were raised against this kind of code enforcement as well (e.g., Berenbeim 1987; Brien 1996; Appelbaum et al. 1998). Essentially, these critics complain that punishments set a negative tone and lead to the fact that code addressees do not strive to obey the code norms because it is the right thing to do but to avoid punishment. Accordingly, code observance becomes less likely under those conditions when code violations can hardly be detected and verified. As a consequence, critics fear a circulars virtuosos because the company will be inclined to establish additional rules for guiding its employees and to carry out additional controls in order to observe whether rules are followed. However, employees will not appreciate being patronized and will be inclined to fill out unavoidably remaining gaps in discordance with the spirit of the code. The aspirational and motivational force a code can exert is crowded out due to this kind of code implementation.

Basically, these criticisms borrow arguments which are very well-known in organization theory because they were originally put forward against bureaucratic forms of organization (e.g., Crozier 1964). This analogy comes as little surprise because codes are formal measures of organizations for coordinating the actions of their members. Whereas these critics show important perils codes can invoke, they are far from being universally valid. These risks do not necessarily become real if the design of the punishments meets standards to be outlined below. The relativity of these criticisms is worth mentioning because otherwise companies would face a dilemma insofar as many constituencies expect them to establish, and execute, negative sanctions against code offenders.

Indispensability of Punishments

General criticisms against code punishments are at odds with the prevailing demand that corporate codes of ethics should include sanctions because they would otherwise be perceived within and outside the company as mere window dressing. Negative sanctions are expected in order to symbolize and substantiate the binding character of the norms put forward by the code. The waiving of these enforcement's feeds the impression that code obedience is up to the addressees’ discretion and not mandatory within the company. As a consequence, codes without sanctions are easily discredited as being ineffective. As Badaracco and Webb (1995) put it: “[W]hen violations go unpunished, codes become simply another wall decoration or file drawer filler”. The lack of an appropriate enforcement system diminishes the credibility attached to codes. Captain (1998) explains that norms “whose violations are not sanctioned lose their credibility”.

In particular, external stakeholders will evaluate the existence of sanctions and use them as a lack us test for verifying the seriousness of the company to implement the code norms even in those situations where being ethical and obeying the code norms appear (at least in the short run) to cost money and impair profits. Carroll (1978) has already pointed out that, Thus, there is a wide consensus that codes need to be backed by sanctions in order to be perceived as normative guides, rather than as a merely voluntary navigator, through ethically demanding situations within the company. Many authors deem sanctions therefore as indispensable. Post (2000), for instance, emphasizes that a This view is shared by practitioners, too, who frequently level the comment “they aren’t worth the paper that they are printed on” at codes when meaningful sanctions are missing (Murphy 1995).

Introducing a system of negative sanctions is furthermore advisable because some advantages of codes cannot be realized otherwise. For instance, the existence of a code can limit the liability or culpability of the company if corporate actors do wrong and break the law. Most prominently, the Federal Sentencing Commission Guidelines offer incentives to establish an ethics and compliance program which contains standards and procedures (i.e., norms) to prevent and detect criminal conduct because such a program can reduce the culpability score and eventually the fine imposed by the court in order to penalize corporate wrongdoings. However, the Federal Sentencing Guidelines are not content with the existence of standards and procedures to prevent and detect criminal conduct. Rather, a compliance and ethics program must also feature means of ensuring the observance of these standards in order to be distinguished as an effective program. Doubtlessly, providing objective evidence that the company has an appropriate enforcement system in place will be much simpler if negative sanctions are established for deterring code violations.

Empirical Evidence

Against this background, the frequency of code sanctions in practice comes as little surprise, notwithstanding the prevalent criticisms against code sanctions to which reference has been made before. The vast majority of corporate codes mention explicitly enforcement or compliance procedures (e.g., Ferrell et al. 1998; Murphy 2000; Carasco and Singh 2003). This share apparently increased over time and tends to be higher among US companies than in other countries a development which is related to different regulatory and legal environments and their changes (Talaulicar 2006). In addition, codes which do not make reference to sanctions can nonetheless be associated with a system of punishments because sanctions can also be communicated through different means (e.g., the organization handbook, the employment contract or other organizational instructions by the employer). In sum, empirical evidence indicates that code sanctions are widely spread and commonly established in firms with codes of ethics.

By contrast, the empirical evidence with regard to the effectiveness of code sanctions is less univocal. In the meantime, several studies have addressed this topic. In concordance with the empirical findings about the effectiveness of codes in general, the results of these studies remain inconsistent, too. Whereas some studies showed that code enforcement is related to higher degrees of ethicality (e.g., Weaver and Ferrell 1977; Trevino and Weaver 2001; Vitell et al. 2003), other studies did not reveal statistically significant associations between code sanctions and their effectiveness (e.g., Weaver 1995; Brief et al. 1996). At large, the need for sanctions seems to outweigh possible objections. For instance, Laczniak and Inderrieden (1987) conclude, “[W]hen sanctions are attached to codes, behavior becomes more ethical in nature”. However, the generality of this relation is hardly tenable. Obviously, sanctions are not either beneficial or harmful. Rather, the benefits of sanctions will depend on the kind of sanctions the company has established and practiced. Yet very little is known about how to design a sanction system which promises effectiveness.

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