The sheer scale of the Panama Papers leak is astonishing. Hackers who broke into the Panamanian law firm Mossack Fonseca’s computer system found 2.6TB of data (mostly emails) relating to 11.5 million documents dating from 1977 through to December 2015, involving a staggering 214,488 legal entities. Most of the public debate has rightly centred around politicians, but 29 Forbes billionaires also turned up in the paperwork, as well as 511 banks – which have in turn helped set up a total of 15,579 companies. Many of these offshore entities have done nothing wrong, but the real power of the Panama Papers affair lays in its emotive connection to much wider public debates, including the use of offshore tax havens, corporate tax avoidance and, crucially, business ethics. 

For investors, a specific mention in the hacked papers might not in itself warrant, for example, excluding a business from a buy list, but it might be a red flag. More to the point, investors might start to look at a business’s tax and offshore incorporation policy as part of a broader investigation into social responsibility. Availability of data based on corporate reporting lines is patchy at best, although getting better. Pertinently, many of the most important issues actually relate to more intangible issues, such as internal culture and management responsibility – intrinsically hard to measure and analyse. But if financial professionals don’t ask, they’ll certainly face more and more pressure from their clients to do so. 

Dulcidio De La Guardia, Economy and Finance Minister of Panama, may be worried about the “significant reputational damage” to his country’s financial sector, but most investors will be worried about the wider impact on how the public views major corporates going forward. The good news on issues of public trust is that British consumers do not seem anti-business as such, but mistrust on certain key issues is growing. On big businesses, for instance, a recent ComRes poll of 2,000 British adults for the Forum of Private Business, shows that over three-quarters (78%) of adults in Britain agree that big businesses are more likely to prioritise profits over high ethical standards, while 74% of adults agree that the majority of big businesses have no concern for small business owners in the UK.

40%
The proportion of people surveyed by the Institute of Business Ethics who believe British businesses are behaving unethicallyThis year’s Edelman Trust Barometer, a global measure of corporate trust, reveals that less than half the general population say they trust businesses. Financial sector trust is especially low, according to the report. The UK-based Institute of Business Ethics (IBE) has also looked at attitudes and found that although 58% of clients believe businesses behave ethically, this means that, “for the fourth year running, almost 40% still believe that British businesses are behaving unethically”. Of the respondents polled, 34% noted that the issue that most concerns them is corporate tax avoidance (the Panama Papers affair will have done little to lower this number), 25% are most concerned about executive pay and 19% said that employees’ ability to speak out about company wrongdoing is their greatest concern. 

A myriad of required responsesIt is increasingly clear that tackling this lack of trust requires a number of responses, starting with board-mandated policies that clearly set out the expected ‘tone from the top’. However, the focus of these policies needs to be well considered in order to truly drive a change in internal culture. As one investor anonymously declared: “The vast majority of corporate ethics programmes concentrate, not on ethics, but compliance (as in: do this and you get fired or arrested), which does nothing to improve ethical culture; the increased sensitivity to right and wrong.” Policies and leadership by example should hold, at the core, company values and principles that demonstrate the desired culture of the business to all staff. 

Businesses are starting to realise the importance of getting this right. According to Philippa Foster Back CBE of the IBE: “There has been significant progress in business ethics, with the level of awareness much higher and business ethics much more proactively talked about.” A recent Trust and Business Project carried out by the Organisation for Economic Co-operation and Development (OECD) looked at business ethics and drew on 88 responses from across the developed world. It found that 80% of boards have an integrity policy and that 86% of boards were either concerned or very concerned about a liability emerging because of the absence of such a policy.

Crucially though, gaps are obvious. The OECD report reveals that the majority of directors have received no training on these policies, although two-thirds do say that they have a specific subcommittee concerned with reputational issues. The survey also finds that most directors think that middle management is the key for delivery, yet only 18% say middle management reports information back to the board. The buck may stop with board-level directors, but that first requires someone in middle management to pass it. Foster Back concedes that middle management is a real challenge. “This is an area which corporates to date have been very poor on in policy terms,” she says.

Grant Thornton’s review of corporate governance in 2015, Trust and integrity – loud and clear?, reports quite different figures, stating that only 46% of companies have CSR policies integrated into their business models. According to Grant Thornton, “more than half of the FTSE 350 seems merely to be paying lip service and, for once, this proportion remains constant regardless of the size of the company".  Moreover, only 24% have updated their risk disclosures from the previous year, meaning companies have performed a “cut and paste”, as described by Philip J Weights, MD Enhanced Banking Governance Zurich & Dubai in a review of the Grant Thornton report. 

Comparing the reports

• 57% of FTSE 350 companies fully comply with the UK Governance Code, down from 61% in 2014
• 69% of FTSE 350 companies that do not comply give good explanations as to why not, up from 59% in 2014
• 55% provide quality shareholder engagement, down from 64% in 2014
• 73% provide incisive, high quality accounts of their business models, up from 61% in 2014
• 13% of chairmen personally discuss culture in their primary statements, up from 5% in 2013



Source: Grant Thornton
The report also states that 13% of chairmen provided personal comment on governance in the primary statement of their company’s annual report, compared with just 5% in 2013. It further observes that one-fifth of FTSE 350 chairmen “give culture the prominence it deserves and provide good insight into this important topic”. 

It also notes an improvement in the quality of explanations provided by companies about how they have not been fully compliant with UK Corporate Governance Code – 69% provided good-quality explanations in 2015 compared with 59% in 2014. 

Investment and efforts Interestingly, the Grant Thornton report reveals major variations between different sectors, with consumer services and technology companies finding reporting on corporate culture and ethics “particularly difficult (or unimportant)”. A third of firms in these sectors make no reference to culture at all. Healthcare companies, on the other hand, provide the greatest insights – perhaps because they have suffered significant reputational damage in light of widely publicised scandals and cultural issues. The report says: “The financial sector has been at the centre of many high-profile governance scandals linked to culture, however, its reporting does not yet reflect the industry’s investment and efforts in this area.” In order to restore trust, financial services need to be even more vocal and transparent about efforts to improve culture and behaviour. 

The late management expert, author and teacher Peter Drucker is famously supposed to have said that “culture eats strategy for breakfast”. If he was right, then reshaping corporates on a more ethical footing requires more than just a policy and a subcommittee. It requires a complete change of culture and governance – one that might actually make financial sense for the investor. In the US, the 2013 National business ethics survey (published in 2015) found that the impact of “effective ethics programmes in large companies is remarkable”, with the rate of misconduct lower and the reporting of misconduct much higher. In effect, strong ethics cultures lead to better workplaces. In businesses with a strong ethics culture, for example, 42% of employees had observed misconduct. In businesses judged to have a weak ethics culture, 87% had observed misconduct.

As well as a policy and culture shift, robust and vibrant corporate culture also needs proper reporting to help influence measurement – and that means a real focus on how employees can speak up if there’s a problem. It might even require Panama-style whistleblowing by a dismayed employee. 

15% 
The increase in the number of calls received by Public Concern at Work in a recent surveyLast year’s Surveys on business ethics report by the IBE found: “While employee awareness of ‘speak up’ arrangements has increased, satisfaction with the outcome of raising a concern has fallen by almost half since 2012, with less than two-fifths now satisfied”. At the European level, the IBE worked with peer groups and found that although 93% of businesses have a speak up policy, 72% do not permit anonymous reporting and 90% have no codes to prevent retaliation against whistleblowers. Perhaps more disturbingly, the UK’s leading whistleblowing charity, Public Concern at Work, recently surveyed its users (from both the private and public sectors) and observed a 15% increase in calls from whistleblowers. Of those callers, 17% talked about ethical concerns with their employees. After they had blown the whistle, 25% of these callers had been dismissed, and a further 24% had resigned.

So, the bottom line seems to be that more corporates are taking the vexed issue of business ethics seriously – especially after the Panama affair. But the challenges facing investors remain. How do outsiders monitor their portfolio businesses? What internal data do they rely on and exactly what is being measured? In the next article on this topic, we'll discuss these points and more.

Human rights and slavery: the next governance minefield?

According to Philippa Foster Back, Director of the Institute of Business Ethics, investors and their portfolio businesses need to be increasingly concerned about the issue of human rights, and slavery in particular. Under recent legislation, any business with a turnover of more than £36m needs to issue a statement that it is monitoring its supply chain in such a way that there is no modern form of human slavery involved. 

This concern dovetails with a broader move among some institutional investors to sign up for the UN Guiding Principles Reporting Framework from February 2015. This declaration says that “companies that do not proactively assess and manage human rights risks face potential legal, reputational, and other risks with financial implications. Meaningful disclosure of human rights performance can play a significant role in reducing a company’s human rights risks, contributing to a company’s competitive advantage, and strengthening its long-term financial stability".

The declaration was signed by a number of leading institutional investors and calls for the “implementation of human rights due diligence, which includes assessing actual and potential human rights risks, integrating and acting upon the findings, tracking the effectiveness of actions taken to address human rights impacts, and communicating about how a company addresses risks and impacts".