WHY CORPORATE AMERICA'S NEW ASSET IS ETHICS, AND ENFORCEMENT OF THE SARBANES-OXLEY ACT OUGHT TO HELP THE STOCK MARKET

WorldCom built its empire on aggressive mergers and acquisitions. So did another company, Cardinal Health. Both companies used incentives like stock options. Both encouraged a strong competitive attitude.

Yet WorldCom has imploded, and Cardinal Health is continuing to grow nicely. What's the difference between the two?

Well, of course, leadership is a big one. WorldCom had a smart management team - but also one that would do just about anything to grow the company. Cardinal Health, however, has a different attitude. More significantly, Cardinal Health took its code of ethics and training seriously, and made it an integral part of the growth strategy.

The truth is, it's not crime that pays - it's behaving in an ethical way. As regulators continue to formulate their responses to 2002's corporate scandals, they should keep that in mind. Rather than being nervous to set down new rules that will reign in corporate wrongdoing, regulators should realize that they are only benefiting (financially, as well as morally) the companies they require to toe the line.

The Sarbanes-Oxley Act is a strong step in the right direction. And if more is needed, regulators should not hesitate to do more.

Cardinal's Ethical Stance: Going to The Government When Problems Arise

Cardinal's example is very instructive. In 2002, Cardinal agreed to purchase another company, Syncor, and thus conducted extensive "due diligence" (that is, a searching inquiry into the finances of the entity it was about to acquire). In the course of due diligence, however, Cardinal noticed alleged illegal payments that had been made to foreign companies, in order to obtain contracts there.

The total amount of the payments? About $500,000, not such a large sum for a multi-billion dollar company. The violation? A rather common one - companies that would never bribe in the U.S. may resort to it abroad, despite its illegality, because they feel that is the only way they can compete.

For these reasons, another acquiring company - anxious to get the deal done - might well have looked the other way. To its credit, Cardinal did not.

Much of that credit belongs to Cardinal CEO, Bob Walter, who founded his company in the early 1970s. Walter, who believes corporate ethics are critical, quickly notified the board of Syncor, as well as governmental authorities.

Why? Cardinal's SEC filings contain quote from one of Walter's company-wide emails that explains it well:

In the end, the deal went through, but Syncor's had to pay fines to governmental agencies and give up millions in compensation. Cardinal, however, knew that it had gotten the company it wanted - one without lingering ethics problems - and that it had done so honorably, abiding by the law and even aiding the government's enforcement of it.

Why the Sarbanes-Oxley Act Is Likely to Actually Benefit Companies Financially

The landmark Sarbanes-Oxley Act, enacted in response to 2002's scandals, is chock full of legal requirements that are really, in a way, ethical requirements too. For instance, the CEO and CFO must certify the company's financial statements, putting their own good names behind them. Disclosure must be more transparent, with regulators and the public knowing what is going on behind company walls.

In addition, there are much stronger audit and conflict-of-interest rules to counteract situations where an auditor overlooks improprieties because its relationship with the company it's auditing is too close. And employees have more rights to engage in whistle-blowing. Meanwhile, the stock exchanges are also requiring independent directors and yes, even codes of ethics.

Unfortunately, some managers will look at complying with the new rules - which admittedly, will have its costs, and consume their time - as pure drudgery. The belief is "there were only a few bad apples, and the rest of us are paying the price." These managers will complain that the Act will hurt U.S. companies when they compete with foreign companies that are not constrained by any such rules.

This reaction is to be expected, for there is always backlash when major regulatory changes occur. Consider, for example, the 1930s when Congress required audits for financial statements, required prospectuses for public offerings, and set up a watch-dog agency called the Securities and Exchange Commission to police the securities markets. Even then, it was met with angry complaints that it had gone too far.

These managers are missing the big picture: The environment is much different. We are really in a New Economy now - one in which ethics is good for business. Rather than being an afterthought, ethics (and the reputation for ethical conduct) should be a part of a company's balance sheet. Companies count business goodwill as an asset; what about a sort of ethics goodwill, reflecting what society and the government know and believe about the company's conduct.

Doing Well By Doing Good: Ethics As An Asset

Money managers on Wall Street are beginning to see this point. For example, when portfolio manager, Thomas Marsico, learned of alleged questionable Medicare practices at Tenet, he wasted no time in selling his 17 million share position. The appearance of impropriety alone was enough for him to lose confidence. (Last year, the Justice Department launched an investigation against Tenet over these practices. Then, last Thursday, the Justice Department sued the firm for Medicare fraud. The firm reportedly tried to reach a settlement, but it has apparently broken down.)

And to take a more obvious example, just look at the stock performances of Enron and WorldCom. They are now penny stocks. And it's not because the companies were poor; it's because they were poor in ethics.

Part of the reason ethical behavior makes for good business, is obviously that it avoids problems that cause the company to lose money. A bad story in the New York Times or 60 Minutes could be devastating. As Warren Buffet once said, "Lose money for the firm, I will be very understanding; lose a shred of reputation for the firm, I will be ruthless." Also, if your company is the brunt of an investigation, it could mean fines and even prison. Inevitably, it means needlessly wasting time and money.

But the point is much deeper than this: Being ethical does not only avert catastrophe, it actually helps growth, in a number of different ways. The benefits may not be immediately apparent; it is important to realize that ethical measures are not a short-term fix, but a long-term phenomenon. (Buffett himself, for instance, has a reputation of impeccable integrity because he has been practicing it on a daily basis for over 40 years.)

Four Reasons Ethical Companies Win Out In The End

Over time, a company will see the benefits of emphasizing and enforcing ethics, in four basic areas.

First, with ethical measures in place and an ethical corporate culture, employees trust the company, and feel that they have a voice. That means they are, in turn, likely to be more encouraged to work harder and to innovate. It also becomes easier to attract talented new employees.

Second, suppliers are more willing to do business with a company they know they can trust. Moreover, it is easier to attract strategic partners - or as in the case of Walter, find good merger candidates - when you have a strong reputation for ethics. (Of course, you won't necessary attract the partners with ethical problems, but that's a good thing.)

Third, with good ethics, and a good reputation for ethics, it becomes easier to attract investment capital. Fourth, and finally, it is easier to get customers - and keep them when these assets are intact.

A Milestone In Economic and Regulatory History Is Happening Right Now

Many of the benefits ethics confer are intangible: Ethics don't take up space in a warehouse, nor can they be used to purchase another company. But the same is true of other valuable intangible property - such as patents, copyright, and business goodwill. Yet everyone understands these intangible assets have tremendous value.

Economic history has many critical milestones: There is the break-up of Standard Oil, which ended trusts; there was the 1930's era of new federal securities regulation; and later, there were the lax antitrust rules of the 1980s and the boom in takeovers (but was the boom only a bubble?).

The year of 2002 was another milestone in corporate history. The scandals concerning Enron, Arthur Andersen, and others taught us a fundamental lesson: Running a company means looking beyond just the interests of "shareholder value."

To prosper, companies must have a broader mandate: They must consider all stakeholders - employees, customers, suppliers, strategic partners, and communities. And they must abide by the law, and by ethical rules and principles. It's not just the right thing to do (though that would be enough), it's also good business.

All in all, this looks like a good trend indeed.