PwC’s Strategy&: CEOs Increasingly Fired for Ethical Violations

VEA Vice Chair Nell Minow writes in Huffington Post:

PwC’s Strategy& released its annual CEO Success Study on Sunday, May 14, 2017. This year’s study explores the rise in the number of CEOs at the world’s 2,500 largest companies who were dismissed from their posts due to ethical lapses.

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As companies like FOX, United, Wells Fargo, Yahoo and VW are scrutinized for corporate wrongdoing, the study found that the share of CEOs forced out of their jobs due to a scandal increased globally– with a notably dramatic increase at companies in the U.S. and Canada. Specifically, the report found:

  • Forced turnovers due to ethical lapses rose from 3.9 percent of all successions in 2007–11 to 5.3 percent in 2012–16 — a 36 percent increase. On a regional basis, the share of all successions attributable to ethical lapses rose sharply in the U.S. and Canada (from 1.6 percent of all successions in 2007–11 to 3.3 percent in 2012–16), in Western Europe (from 4.2 percent to 5.9 percent), and in the BRIC countries (from 3.6 percent to 8.8 percent).
  • In the U.S. and Canada, forced turnovers for ethical lapses at these companies increased from 1.6 percent of all successions in 2007–11 to 3.3 percent in 2012–16 — a 102 percent increase
  • The share of incoming women CEOs increased globally to 3.6 percent, rebounding from the previous year’s low point of 2.8 percent

Per-Ola Karlsson, DeAnne Aguirre, Kristin Rivera, and Gary L. Neilson, who prepared the report, identified increased public scrutiny and pressure, the rapidity and influence of digital-era feedback, and post-financial crisis regulatory requirements as primary factors in the increase of CEO departures for ethical concerns. The report does not examine the impact of an ethics-based departure on compensation or the correlation between board or shareholder composition and likelihood of such a termination.

In an interview, the authors explained their definition of “ethical lapse” and discussed the impact of social media and the difference between US/Canada CEOs and those in other countries.

What constitutes an ethical lapse for purposes of this study?

An ethical lapse might include fraud, bribery, insider trading, environmental disasters, inflated resumes, and sexual indiscretions. In the context of dismissals, we define an ethical lapse as a scandal or improper conduct by the CEO or other employees that results in the removal of the CEO.

It should be noted that in many cases, even though the CEO was ultimately held responsible, it was other employees who committed ethical lapses.

Are CEOs replaced for ethical lapses most likely to be insiders or those brought in from outside?

We found that there was no statistical difference in the dismissal rate for ethical lapses between insiders and outsiders. We did find that CEOs forced out of office for ethical lapses had longer median tenures than CEOs forced out for other reasons (6.5 years compared to 4.8). One possible explanation is that companies with long-serving CEOs tend to be those that have been achieving above-average financial results, and thus may attract less shareholder and media scrutiny than companies that have been performing poorly. Another is that when an organization’s leadership is static, employees may begin to see ethical lapses as normal, and allegations of misconduct are less likely to be raised, investigated, or acted on.

How has social media put pressure on boards to replace CEOs?

Today, social media plays a large role in not only disseminating negative or embarrassing information about a company, but also allows customers and other parties to directly voice their displeasure to the company and its executives. Often times, the social media backlash becomes a story in itself beyond the negative or embarrassing information which puts extra pressure on boards who may feel they need to implement change in order to take the company out of the negative spotlight.

How does the US compare to other countries in the rates and reasons for CEO dismissal?

In 2016, The U.S./Canada has a CEO turnover rate of 14.2% compared to 15.3% in Western Europe, 15.5% in Japan, and 14.9% globally. Removing, M&A 29% of turnovers in the U.S./Canada were forced compared to 38% in Western Europe, 13% in Japan, and 29% globally. Historically the U.S./Canada has had a lower CEO turnover rate than other regions which is likely due to the fact that companies in the U.S./Canada have more developed governance and succession practices.

In addition, we note in the study this year that companies in the U.S./Canada have the lowest incidence of ethical lapses. Similar to the point about governance and succession practices, companies in the U.S./Canada tend to have more stringent regulation and internal controls than other regions.

What did your study show about women CEOs?

Globally, companies appointed 12 women CEOs in 2016—3.6 percent of the incoming class. This marks a return of the slow-moving trend towards greater diversity—and a recovery from 2015’s recent low point of 2.8 percent.

The share of incoming women CEOs was highest in the U.S. and Canada—rebounding to 5.7% after falling for the previous three years.

We stand by our belief that as much as a third of incoming CEOs around the world will be female. Some of the trends we cited in the 2014 study that supported this findings were: increasing amounts of women on boards, increasing women undergraduates and MBAs, and changing social norms.

What role does shareholder pressure play in replacement of CEOs?

Boards have become much more independent and very infrequently in a position of deferring to the imperial CEO of yesterday. They listen. They listen to shareholders, regulators, other managers. Shareholders don’t want distractions. Our analysis has shown forced CEO turnovers (for ethical lapses or other reasons) are hugely expensive. We found that, on average, forced turnovers cause a hit of $1.8 billion in shareholder value compared to planned transitions. So, by getting ahead of problems, even when they happen, Boards have the incentive to deal with…. ideally in a “planned” way, even if the change wasn’t part of the individual CEO’s plans!

The World’s Most Ethical Companies 2017

Through its ethics survey, Ethisphere evaluates firms on five criteria, which roll up into a single Ethics Quotient (EQ) score. The first and most important topic is a company’s ethics and compliance program, which accounts for 35% of the EQ. Firms must answer questions like whether they track gifts received by employees and what resources they offer employees for reporting misconduct.

Ethisphere observed an interesting trend in the data in 2016: more companies disclosed information about misconduct to their own employees, telling them how many complaints were filed and what was done about it. Previously, firms tended to keep such matters confidential, says Michael Byrne, Ethisphere’s general counsel. “Essential to an effective compliance program is people feeling comfortable expressing a concern … One of the best ways to [do that] is to shine a light on it.”  

The second factor in the ethical list scoring, accounting for 20% of the EQ, gauges whether ethics are embedded into a company’s culture from top to bottom. The third element, corporate citizenship and responsibility, includes questions about what methods companies use to measure their environmental impact.

Corporate governance is the fourth criterion. Ethisphere’s survey asks whether a company’s CEO and board-chair roles are held by separate people. This year, Ethisphere also placed an increased focus on diversity in board and leadership positions.

The final element is leadership, innovation and reputation. Ethisphere asks if companies have been named to top business lists, such as Forbes’ own Most Trustworthy Companies, and whether its executives have spoken at high-profile conferences like the World Economic Forum in Davos, Switzerland.

Of the 124 firms on this year’s list, 13 have made the cut every single year, including: Aflac, Deere & Company, Ecolab, Fluor, GE, International Paper, Kao Corporation, Milliken and Company, PepsiCo, Starbucks, Texas Instruments, UPS and Xerox.

Source: The World’s Most Ethical Companies 2017