Tone at the Top

Posted in Risk Management on May 31, 2024
Tone At The Top

Tone at the top is a term used in auditing to describe the leadership of a company’s management and board of directors, as well as their commitment to being honest and ethical. The tone at the top establishes the cultural environment and corporate values of a company.

In early 2000, high-level corporate scandals threw businesses into ongoing turmoil, causing losses and exposing them to systematic abuse of power and dishonest business practices. The companies included Enron, Adelphia Communications in the United States, CINAR in Canada, Swissair in Switzerland, FlowTex in Germany, MG Rover Group in the UK, Tyco International in the Republic of Ireland, etc. 

Most of these corporate collapses were associated with the top management with widely exercised corrupt practices. The lack of an adequate control environment and corporate governance contributed to the widespread violations and exploitation of accounting loopholes.

These scandals emphasized the definition of “tone at the top” as a preventive initiative to establish the right governance and culture in organizations. Several countries adopted legislative measures aimed at reducing misconduct. The most well-known of these regulations are the Sarbanes–Oxley Act or SOX of July 2002 and the United States Federal Sentencing Guidelines. They established guidelines for enforcing and promoting the tone at the top. 

Tone At The Top

SOX section 404 defines risk management responsibilities, such as auditing and reporting on an internal control system. Management in SOX refers to the board of directors, emphasizing the CEO and CFO. It is emphasized that responsibilities defined by SOX are statutory rather than guidance.

Another example is The Organization of Economic Cooperation and Development or OECD. It issues Good Practice Guidance, urging companies to promote a system of ethics and a culture of integrity, which promotes effective standards of corporate governance and investor stewardship as an integral part of a comprehensive framework for reputation risk management. 

What is the Tone at the Top, and Why Does it Matter?

In general, people may behave in a non-compliant manner for various reasons:

  1. Non-compliant behavior without specific intention,
  2. Non-compliant behavior to benefit the organization, and
  3. Non-compliant behavior to benefit oneself.

To effectively prevent non-compliant behavior, it is crucial to understand what facilitates it. Consequently, if the organization also profits from such behavior, employees can more easily justify their non-compliant behavior morally because they can also interpret the rule violation as desirable from the company’s perspective. In particular, in a business context, employees use the excuse that “everyone is doing it” to disengage from non-compliant actions morally.

Previous research indicates that the tone at the top expresses ethical values in the organization and provides guidance to employees.

The term “tone at the top” refers to an organization’s overall ethical climate established by the board of directors and senior management. It establishes the guiding principles and is the most crucial element of the control environment. Management sets the tone at the top, and employees are more likely to uphold the same values if management sets a good example of honesty, integrity, and ethics.

Weaknesses in the “Tone at the top” have been associated with most modern financial frauds. Poor tone at the top may include negligence of internal controls, an overemphasis on profits at the expense of ethics, a belief that compliance with the law is sufficient for defensible ethical conduct, and the accommodating of some stakeholders.

However, it does not apply to others where there is blaming higher-ups or colleagues for unethical practices, having one’s judgment clouded due to conflicts of interest, and a misunderstanding of and lack of adherence to public expectations of what constitutes ethical behavior for executives.

To ensure a proper tone at the top, the management and those charged with authority must implement some adequate measures. Among these, the following components may be highlighted:

  • Lead By Example: Managers must set the right tone by leading by example and with integrity. Through their actions, leaders should demonstrate their commitment to honesty, ethical strength, dependability, and fairness. Management cannot act without these characteristics and expect others to behave differently.
  • Communicating and Promoting Ethics and Values: Management must communicate its ethics and values clearly throughout the area they manage. These values could be communicated formally through written codes of conduct and policies, staff meetings, memos, etc., or informally during day-to-day operations.
  • Reporting: It is crucial to create channels for employees who are witnessing unethical behavior to be able to report such behavior. Employees are responsible for reporting such activity to management and should feel safe from retaliation. Managers should make their employees aware of the Reporting Hotline and encourage them to use the channels whenever misconduct is determined.
  • Reward Integrity: Employees who exhibit honesty and integrity should also be recognized, which will help communicate management’s commitment to this behavior and encourage others to follow suit. Such will promote integrity and have a positive impact on others.
  • Embedding Systems and Processes to Support the Tone at the Top: Implementing and promoting an ethical tone of “business as usual” will help shape the organizational culture and measure the effectiveness of leadership actions and behaviors over time.

Each level of the organization’s management should have its share of accountability, which will help to shape and maintain strong corporate governance in the company.

Under the Sarbanes-Oxley Act, profound corporate governance entails clearly defining the roles and responsibilities of the Board, directors, CEO, and other officers, strengthening audit committees, performing internal controls tests, and holding directors and officers personally liable for the accuracy of financial statements, and strengthening disclosure.

Tone at the Top and Corporate Culture

The proper tone from the top is critical, but it will dissipate fast unless there is a genuine and ongoing commitment from the board and senior leadership, including the chief compliance officer and the chief audit executive, to send the right message using various media, as well as building relationships throughout the organization one at a time. You could be encouraging misconduct without the right tone from the top and clear message communication. These are the building elements of a healthy and sustainable environment, which eventually shape the organization’s corporate culture.

Culture is the shared attitudes, values, goals, and practices that characterize an institution or organization. It is the extent to which an organization regards its values. Strong ethical cultures make doing what is right a priority. Ethical culture is often an unwritten code by which employees learn what they

should think and do. Cultural norms define what is encouraged, discouraged, accepted, or rejected within a group. When properly aligned with personal values, drives, and needs, culture can unleash tremendous energy toward a shared purpose and foster an organization’s capacity to thrive.

Visually, the corporate culture of the organization can be presented as an overlapping diagram of the following items;  

Some of today’s best organizations promote ethics and culture as a critical part of their corporate branding and values because doing the right thing, even when no one is watching, is profitable and is called the “ethical premium.” The correlation between organizational justness and performance shows that organizations with morals and ethics often outperform.

The business benefits of a culture that an organization may enjoy include, among others, the following:

  • Increased reputation and positive public image
  • More stable and consistent reaction to ever-changing rules/laws
  • Social media regulations
  • Effective recruitment and reduced turnover
  • Less disruptive workplace. 

Creating an integrity culture begins with tone at the top, but it must include mood in the middle and buzz at the bottom. Culture is defined as what people perceive to be recognized and rewarded. Employees’ supervisors may be the face of culture. As a result, senior leadership should serve as both a driver and a critical contributor to corporate culture.

A manager can be a leader, but a manager is not always a leader. The workgroup leader may emerge informally as the group’s choice. The manager demonstrates leadership if manager can persuade others to work toward the organization’s goals without using formal authority.

The key distinction between leadership and management is that employees follow leaders because they want to, not because they have to. Leaders may not have the formal authority to reward or sanction performance because leadership does not always occur within the organization’s hierarchical structure. On the one hand, employees give the leader power by complying with their requests. On the other hand, managers may need to rely on formal authority to motivate employees to achieve goals.

Tone At The Top

Some scholars proposed that there are two types of leaders:

  • Transactional leaders see the relationship with their followers in terms of trade: they give followers the rewards they want in exchange for service, loyalty, and compliance.
  • Transformational leaders see their role as inspiring and motivating others to work at levels beyond mere compliance. Only transformational leadership is said to be able to change team/organizational cultures and move them in a new direction.

Transactional leaders tend to be more passive, and transformational leaders are more proactive. While a transactional leader would work within the confines of the organizational culture, the transactional leader would seek to change and improve the culture. Transformational leadership enhances the motivation, morale, and job performance of followers.

Effective Leadership will act as a role model and inspire others to develop and innovate. They would advocate empowerment, encouraging followers to take greater ownership of their work. Transformational leadership has become more important in recent years.

The dynamic nature of the environment facing many organizations today means a constant need to innovate and change. To cope with this type of environment, leaders need to have vision and creativity, be innovative, and be capable of inspiring others.

The distinguishing feature of transformational leadership is the ability to bring about significant change.

Communication is important in reinforcing the change and establishing tone at the top in business processes and people’s mindsets. It can be realized through various channels, and here we will provide some practical methods for developing this, on the example of VEON Armenia.

The most successful and effective channels are proven to include a live interaction between the senior leadership and employees of the company. Employees must observe and understand that the company’s senior leadership adheres to and follows business ethics requirements and consistently demonstrates this by personal example. The effective channel for establishing a top-down tone is to emphasize and communicate important topics at the highest possible level.

To this end, it is critical to hold a sufficient number of meetings, at least quarterly, and to cover as many important topics as possible. There is a common practice to invite a senior leadership team member as a speaker and to deliver a presentation to the audience. The subject can include themes on Internal Control and Risk Management, Government and Regulatory Affairs, and Legal and HR-related matters. This initiative provides an excellent opportunity to address various aspects of the compliance program and get valuable personnel feedback.

It is also very important to constantly shift the subject and format of town halls, maintain the people’s interest, keep them involved and avoid repeating the same approach. Such helps ease nervousness and anxiety and establishes a more informal discussion.

The final but not least important channel for establishing proper tone is regional visits by senior leadership. The tone set at the top should apply to the entire company, including its remote regional divisions, rather than just the headquarters.

Of course, these are just examples: in practice, they will vary depending on the organization’s size, structure, nature, and industry. However, such activities will ensure that senior leadership and employees are on the same page and that corporate values are shared, adequately communicated, and followed by everyone in the company.

Final Thoughts

Organizational management is becoming increasingly difficult in today’s ever-changing business world. Nonetheless, efforts to implement and maintain an ethical approach to governance may aid in easing and overcoming modern organizations’ challenges.

A good place to start is to set the appropriate tone at the top; this will serve as the foundation for the organization’s trust, common interests, values, and ultimate goals.

It is critical to understand the prevailing culture before attempting to make broad-sweeping changes to inform and drive tone from the top messages. Public resources and corporate codes, such as the UK Corporate Governance Code, OECD Good Practice Guidance, ICGN Global Governance Principles, and others, may be used as benchmarks. Suppose the organization already has a good standing in this respect. In that case, careful consideration must be taken, whether it will be justified to reinforce new, fundamental changes and how they might affect the performance and overall environment of the company. In many cases, an appropriate balance should be achieved whenever possible.

Another point that must be recognized in developing the tone is the overwhelming expansion of social media and mobile technologies. The world is becoming increasingly integrated. As a result, any improper action or word can instantly go viral, thus undermining the years of efforts to establish an appropriate ethical tone.

After all, as Warren Buffett once said – “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently”.