Corporate Social Responsibility (CSR)

Corporate Scandals and the Sarbanes-Oxley Act

Celebrity scandals often create "buzz" and can actually make celebrities richer. But scandals in the business world frequently lead to the forfeiture of millions of dollars—and to prison sentences. Some notable corporate scandals are illustrated below.

In the 1990s and early 2000s, several corporate scandals revealed in the United States exposed a lack of board vigilance. Perhaps the most famous involved Enron, whose executives' antics were documented in the film The Smartest Guys in the Room. Enron used accounting loopholes to hide billions of dollars in failed deals. When the scandal was discovered, top management cashed out millions in stock options while preventing lower-level employees from selling their stock. Enron's collective acts led many employees to lose all of their retirement holdings and their jobs; stockholders lost $74 billion; and many Enron executives were sentenced to prison. The scandal also caused the dissolution of Enron's outside accounting firm, Arthur Andersen, then one of the five largest accounting firms in the world.

Around the same time as Enron, other corporate scandals caused colossal damage. WorldCom, a telecommunications firm, inflated its assets; when this was discovered, shareholders lost $180 billion and 30,000 employees lost their jobs. In another famous case, the CEO and CFO of Tyco stole $150 million and inflated company revenues by $500 million. Before being discovered, the CEO threw a $2 million birthday party for his wife on a Mediterranean island, paid for with company funds. Both the CEO and CFO went to prison.

In response to notable corporate scandals at Enron, WorldCom, Tyco, and other firms, Congress passed sweeping new legislation in hopes of restoring investor confidence while preventing future scandals (Table 11.1). Signed into law by President George W. Bush in 2002, the Sarbanes-Oxley Act contained 11 aspects that represented some of the most far-reaching reforms since the presidency of Franklin Roosevelt. These reforms created improved standards affecting all publicly traded firms in the United States. The key elements of each aspect of the act are summarized below:

1. Because accounting firms were implicated in corporate scandals, an oversight board was created to oversee auditing activities.
2. Standards now exist to ensure auditors are truly independent and not subject to conflicts of interest regarding the companies they represent.
3. Enron executives claimed they had no idea what was going on in their company, but the act requires senior executives to take personal responsibility for the accuracy of financial statements.
4. Enhanced reporting is now required to create more transparency about a firm's financial condition.
5. Securities analysts must disclose potential conflicts of interest.
6. To prevent CEOs from claiming tax fraud is present at their firms, CEOs must personally sign the firm's tax return.
7. The Securities and Exchange Commission (SEC) now has expanded authority to censure or bar securities analysts from acting as brokers, advisers, or dealers.
8. Reports from the comptroller general are required to monitor any consolidations among public accounting firms, the role of credit agencies in securities market operations, securities violations, and enforcement actions.
9. Criminal penalties now exist for altering or destroying financial records.
10. Significant criminal penalties now exist for white-collar crimes.
11. The SEC can freeze unusually large transactions if fraud is suspected.

The changes that prompted the Sarbanes-Oxley Act were so sweeping that comedian Jon Stewart quipped, "Did Wall Street have any rules before this? Can you just shoot a guy for looking at you wrong?" Despite the act's considerable merits, no legislation can be a cure-all for corporate scandal (Table 11.2). As evidence, the Bernard Madoff scandal that broke in 2008 represented the largest investor fraud ever committed by an individual—but in contrast to some earlier scandals that resulted in relatively minor punishments, Madoff was sentenced to 150 years in prison.

Did the Sarbanes-Oxley Act help reduce corporate scandals? Maybe—but unfortunately they have continued. More notable examples include HealthSouth, Freddie Mac, American International Group (AIG), and Lehman Brothers. Accounting and financial misdeeds are not the only type of corporate scandal that still plagues the corporate environment. More recent scandals have involved Volkswagen (emissions fraud), Uber (sexual harassment), Apple (deliberately slowing devices), Facebook (data harvesting without consent), Boeing (skirting FAA rules), and various pharmaceutical companies that unethically pushed sales of opioid medications, worsening the opioid epidemic. As noted, not all corporate scandals are financial in nature, but they are typically driven by greed and provide a financial benefit for individuals or companies.

In the early 2000s, highly publicized fraud at Enron, WorldCom, Tyco, and other firms revealed significant issues—including conflicts of interest by auditors and securities analysts, boardroom failures, and inadequate funding of the Securities and Exchange Commission. In response, Senator Paul Sarbanes and Representative Michael Oxley sponsored legislation that contained what former President George W. Bush called "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt." The 11 key aspects of the law are outlined below.

Section Video

The Ethics of Business: Where and Why It Can Go Wrong

This video explains the ethics of business, and where and why it can go wrong.

Ethics and CSR as Corporate Strategy

One positive outcome of the corporate scandals has been an increased focus by firms on corporate ethics. Many companies now have an Ethics and Compliance Officer and a detailed Ethics and Compliance Code. For example, Walmart's Global Ethics and Compliance Program is provided online for the public and runs to numerous pages (Walmart, n.d.). Many firms provide annual training to all employees on their company's ethics and compliance standards.

Below is the table of contents for Facebook's Code of Conduct. Although this is a typical approach to a code of conduct, it does not necessarily mean a company is perceived as ethical—particularly as Facebook has faced pressure to reconcile its commitments to "free speech" with accusations of promoting hate speech.

Another form of regulation designed to prevent corporate misbehavior involves "whistleblower" laws and policies. Many firms intentionally encourage employees to report any suspected misconduct by the firm, its managers, or its employees. A whistleblower hotline is often provided so suspected violations can be reported anonymously, and anti-retaliation policies encourage employees to come forward without fear of retaliation or losing their jobs. Although all these measures are helpful, fraud and misconduct still occur.

In response to persistent rule-breaking by corporate actors, Corporate Social Responsibility (CSR) emerged in the 1970s to assert that a "social contract" exists between business and society. At its base is the assumption that a business thrives when the society it relies on thrives, and that firms therefore have a duty to give back more than profit to their environment. CSR is a business model that attempts to "give back" to the members of the community or society who help the firm succeed by purchasing its products or services. Its goal is to enhance the success of a business by enhancing the society in which the organization operates. CSR can take the form of philanthropy or donating funds to causes important to a firm's stakeholders. Some forms include corporate volunteerism—such as asking employees to help build a Habitat for Humanity house on a Saturday—and improving environmental sustainability, one of the most recognized recent forms of CSR.

Many firms adopt the Triple Bottom Line approach to guide their CSR philosophy. In the triple bottom line, the company focuses on the three P's: profit, planet, and people. CSR is discussed in more detail later in this chapter.

Section Videos

What Is Business Ethics?

The video for this lesson explains personal business ethics.

What Is Ethics? What Is Business Ethics?

This second video for the lesson focuses on business ethics.

Key Takeaway

• Firms can have a positive or negative impact on society. Corporate scandals have caused tremendous losses for shareholders, employees, and other stakeholders. The government has passed various regulations, such as the Sarbanes-Oxley Act, in attempts to thwart unethical and illegal company behavior—yet such behavior continues. A company's board of directors has the ultimate responsibility for ensuring ethical behavior on the part of the organization and its CEO. Senior management may be tempted to act in its own interest instead of the firm's best interests, which is called the agency problem. On the positive side, many firms have adopted the philosophy and activities of corporate social responsibility, or creating shared value. Ethical issues will continue to confront firms and their leadership teams. Adhering to a company's core values and keeping the firm's best interests as the priority will help guide leaders to the best decisions.