Family-run firms may be failing to maximize value

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Family-run firms may be failing to maximize value

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Keith T. Darcy. Executive director of the Ethics & Compliance Officer Association

Corporate ethics and governance are increasingly taking center stage in Korea as business scandals continue their run across newspaper headlines.

The issue raised its head again last week when the third official from a savings bank took his own life as he was being investigated on suspicion of corruption. This comes as the family owners of SK Group, the nation’s third-largest conglomerate, face trial for embezzlement.

Cleaning up the way businesses are run is a specialty of Keith T. Darcy, executive director of the not-for-profit Ethics & Compliance Officer Association. This ranks as the world’s largest association for executives who focus on ethics and compliance, with over 1,200 members worldwide.

Having spent 35 years as a Wall Street banker, Darcy has sat on the board of large U.S. banks such as E*Trade and New York National. He also served in executive posts at the boutique bank IBJ Whitehall and insurer IGM, and established the first ethics office among Wall Street firms at Prudential Securities before devoting his energies to ECOA on a full-time basis in 2004.

Moreover, he has been teaching ethics and leadership to executives at the University of Pennsylvania’s Wharton School since 1994.

Darcy recently sat down with the Korea JoongAng Daily to talk about business ethics and corporate governance in Korea and Asia.

Q. Does the top-down, family-run nature of Korean conglomerates make them more susceptible to ethical violations?

A. Yes, because it’s a conflict of interest to begin with. Approximately two-thirds of companies in Asia are family-run businesses [with the exception of Japan]. At some point, I think Asian companies need to prepare for non-family leadership. How can you pass the company on to a family member indefinitely, to how many generations?

I’ll point to IBM. Thomas Watson, Sr., who became head of the company in 1914, was succeeded by Thomas Watson Jr. - and for nearly six decades, the values of the family became the values of the organization.

Now, Thomas Watson, Sr. had a “no-layoff” policy. As the company grew, the strategy was derailed and they ran into a real financial problem. When John Akers was brought in [as CEO] 1985, he had to fire some 120,000 people. Now, I don’t think a Watson family member would have done that.

At some point, bringing in professional management is preferable in viewing the greater value of the company in a global context. But it will take at least a whole generation to change the system.

What about corporate ethics and governance in Korea?

Koreans need to understand that the world around them is changing, and [Korea] is going to be subject to that. You can’t stay in the chaebol system forever. Governance standards and corruption risks are changing.

For example, most of the chaebol do business in the U.K. in some shape or form, and this makes them subject to the U.K. bribery bill, which went into effect on July 1 last year. A bribe could take place here in Korea, but if a company does business anywhere in the U.K., it’s subject to that bill.

Moreover, in March 2011, an OECD working group of 44 nations, including Korea, agreed to promote ethics and compliance programs in their respective countries and to hold each other accountable in peer-to-peer assessments. I predicted it would take seven to 10 years before we saw results, but the system is in place.

But does it pay off to be an ethical business?

Siemens AG once had a widespread, systematic scheme for bribery and corruption that went on for decades. After the scandal broke [in 2006 and 2007], Siemens only paid a $1.6 million settlement to U.S. and German regulators because it was required to implement a comprehensive compliance program, which cost Siemens $1.2 billion extra per year. Siemens wasn’t sure if it could absorb the cost, but in 2010, Siemens’ year-end financial results were record earnings. It told everybody in the company that you can do it the right way and still succeed.

You want to know what your company’s reputation is worth [and] there’s a financial value attached to it - your market capitalization. [After its spill in the Gulf of Mexico in 2010] BP’s stock went down $100 billion. [During its fraud scandal after the 2008 financial crisis] Goldman Sachs’ went down $100 billion. [And during its current fraud scandal] Olympus almost got delisted.

There is a pattern of flight to integrity in our markets. Investors in scandal-ridden companies will sell their shares and move their money elsewhere, especially in the U.S.

Similarly, capital formations will flow to Korea to the extent in which the country’s systems can be trusted. If not, there’s going to be fewer and fewer joint venture partnerships, less foreign direct investment.

As you said, there has been a profound loss of trust in our markets, corporations, governments and leaders. How do you rebuild trust?

When things go bad, somebody somewhere must get up and tell the truth.

I think of Johnson & Johnson. When 16 people died of tainted Tylenol capsules [between 1982 and 1986], then-CEO James E. Burke publicly appeared on talk shows to inform audiences what steps the company was taking, and to ask what else they could do.

The company initially came back with a tamper-proof bottle, which led analysts to dump the stocks because the bottle was an extra cost that competitors didn’t have.

Johnson & Johnson’s U.S. aspirin market share of 38 percent had fallen to zero when it pulled all products off the shelf. But when it came back with the tamper-proof bottle, the company’s market share went to 44 percent overnight.

The rebuilding of trust has to be a continuous process. If you can do it right, and do it well, people will forgive you. BP is now getting some praise for their efforts in trying to provide restitution for the people harmed [by the oil spill].

Is it possible to prevent scandals?

Prevention is possible, but I don’t know that it can be mandated by governments. I’m a downside risk manager - I’ve worked on Wall Street for 35 years, ran a bank and an insurance company - and if you really understood risk, you’d know it gets back to self-regulation.

We have seen a number of companies get into trouble that met corporate ethics and governance standards by having an empowered, high-ranking officer in charge of the program, then after a while degraded the program to a lower rung of the corporation. Every time business fails to set its own boundaries, the government will step in. But in my experience, you can’t legislate trust.


By Lee Jung-yoon [joyce@joongang.co.kr]

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