Poorly managed corporate risk all too often becomes risk that stakeholders unwittingly end up assuming. The consequences can be dire: Think deaths and accidents from unintended acceleration in now-recalled Toyota vehicles, the shocking demise of Lehman Bros. that fueled the global economic meltdown, or the deaths of oil platform workers in the explosion that started BP’s environmental catastrophe in the Gulf of Mexico.

Scandal affecting public figures also continually demonstrates the high costs of poorly managed risk. Estimates are, for example, that Tiger Woods lost between $23 to $30 million in endorsement deals last year, even though according to Forbes, he still topped other sports icons’ endorsements.  Finance professors at University of California at Davis estimated that shareholders of companies sponsoring Woods lost between $5 billion to $12 billion  in market value from November 17, 2009, when the scandals around his private life broke, to December 17, 2009.

Especially troubling here is that no matter how many examples establish irrevocably the very high human and financial consequences of reputation damage, and no matter how often leaders talk about the importance of having or regaining trust and reputation, the examples keep happening in different companies, with different leaders, with harm inflicted in different ways. It is almost a perverse corporate version of the movie “Groundhog Day” in which a calamitous day keeps repeating itself until the hero figures out what he has to do differently to find a way out.

Risk Management and Ethics

When will it be the right time for corporate leaders to do things differently? Mediator extraordinaire Kenneth Feinberg can’t be everywhere. His newest assignment is administering BP’s $20 billion oil damages fund; his intervention deemed necessary because there was little trust in BP’s handling of the claims.

A recent supplemental research report by the Ethics Resource Center observes that companies are put at risk when leaders fail to see that ethical leadership  is a vital component of effective and responsible management.

Companies that put themselves at risk and whose behavior is also considered to have contributed to the financial meltdown have been required to appear at so many hearings, they’ve worn a virtual path to Washington DC. On June 30 and July 1, 2010, Goldman Sachs and AIG face questions from the Financial Crisis Inquiry Commission on The Role of Derivatives in the Financial Crisis.  In that venue, companies are seen as the problem, not part of the solution; so the public relations hits to reputation are high.

The jury is out on what it will take to convince corporate leaders to build into their risk management strategies the capacity to ask crucial questions about ethical liability, as is done with legal liability. Such a step, hardly radical, would have the objective of putting ethical conduct on the table as a deliberate outcome; evaluating business strategies and actions to assess the potential for unintended consequences that could harm credibility, trust, reputation, and their stakeholders.

Getting on the Bandwagon

An easier way to court public favor seems to be on the sustainability bandwagon. A recently-released UN Global Compact/Accenture Survey (PDF) states, “Demonstrating a visible and authentic commitment to sustainability is especially important to CEOs because it is part of an urgent need to regain and rebuild trust from the public and key stakeholders...trust that was shaken by the recent global financial crisis.” Of the 766 global CEOs surveyed, 72 percent say “strengthening brand, trust and reputation is the strongest motivator for taking action on sustainability issues.”

One of the disconnects pointed out in the survey is that CEOs often assume their own company is more respected and trusted than their industry. This can fuel arrogance and lead to miscalculations. However, even having more trust and respect than accorded others in your industry can evaporate fast as we saw when Toyota’s gold standard of quality fell like a house of cards. Another disconnect is that while 92 percent of CEOs say sustainability should be embedded throughout the organization, only 59 percent are actually doing that. So, how much weight do we give here for intentions?

While 54 percent of CEOs say sustainability will be fully integrated in core business in another 10 years, the qualifiers are based on a number of factors coming into play, including creating a viable market for sustainable products and services. So bets are hedged. Also problematic is the 72 percent of CEOs who say brand, trust and reputation (essentially intangibles) are their biggest motivators for sustainability; standard drivers for business decisions like revenue growth, cost reduction, personal motivation and customer demand are motivators for less than half the CEOs.

This begs the question: Will CEO commitment for sustainability have the enduring motivation to do the hard work of building ethical and responsible corporate policies and practices? Or is it a public relations placeholder until something else comes along?  Commitment to making sustainability real would be a big step forward in ethical leadership. So too would consciously looking at potential ethical liabilities, before taking a course of action. Continuing with business as usual and expecting different outcomes is my definition of insanity. The lessons of the past several months offer ample reason to ensure that ethical considerations are paramount in corporate risk assessment.

Gael O’Brien is a Business Ethics Magazine columnist. Gael is a thought leader on building leadership, trust, and reputation and writes The Week in Ethics, a weekly column at http://theweekinethics.wordpress.com

As we enter the New Year, with familiar chat of resolutions and crystal balls, it would be interesting to glimpse the future - maybe five years from now - to see how the issue of excessive executive compensation has played out in the business world.   The outrage over salaries and bonuses at Wall Street firms, and the role they play in encouraging risky behavior by those organizations, is real and still politically raw. Yet for all of President Obama's recent criticism of "fat cats" on Wall Street, his administration and the Congress have thus far proven unable to even begin addressing the issue in any fundamental way.

New evidence of that can be found in the current The New York Times Magazine cover story, "What's a Bailed-Out Banker Really Worth?" which focuses on the work of Kenneth Feinberg, the Washington, D.C. attorney appointed to serve as "pay czar" for companies receiving bailouts under the federal TARP (Troubled Asset Relief) program.  Writer Steve Brill examines the process by which Feinberg developed and has attempted to implement a program that would limit cash salaries (to no more than $500,000 annually) while replacing cash bonuses with stock that would have to be held for several years before shares could be sold.

It's an issue of enormous complexity.   As Brill notes, "over the last 50 years, the ratio of top pay to average pay at public companies has multiplied roughly 11 times (24:1 to 275:1).  That's more pay in one workday for the chief executive than his average employee makes in a year."   On the other hand, "whatever the approach, even defining fair compensation is harder than it looks, as is implementing reforms that don't have unintended consequences."

Indeed, after spending most of his energy detailing the politically adroit fashion in which Feinberg has dealt with executives of insurance giant AIG (now 80 percent-owned by the U.S. government), Brill spends relatively little time examining the bigger picture and potential solutions.   His pessimistic conclusion:

The larger issue isn’t whether we should admire Feinberg for finessing his way to a middle ground or jeer him for not throwing down the gauntlet. Rather, the clearest lesson that has emerged so far from his nine months of tortured choreography is that if it’s this hard to inject even a limited measure of common sense into the way executives are paid at companies that taxpayers partly own and control, broader change requires a boardroom upheaval.

Brill quotes experts such as Professor Jonathan Macey of Yale Law School, who has written widely about how government efforts to regulate pay have backfired, arguing that corporate boards are the only route to real change. “What I object to about the process Feinberg engaged in,” Macey tells Brill, “is the pretense that he can develop some superior system. . . . It’s not that people in charge don’t know how; it’s that they don’t want to."  In fact, Brill suggests, one key to reform of executive compensation practices may be pension funds and other institutional shareholders who have the expertise and power to influence boards of the companies they own.

Federal legislation requiring an annual "say-on-pay" advisory vote by investors has been approved by the U.S. House of Representatives; similar legislation is pending in the Senate.  Financial services giant Goldman Sachs Group last month agreed to hold an advisory shareholder pay vote.  So far, at least 38 U.S. companies have pledged to hold voluntary “say on pay” votes on compensation, and  in the 2010 proxy season institutional investors plan to introduce about 100 proposals seeking annual advisory votes on compensation, according to RiskMetrics, a leading provider of risk management and proxy advisory services.