Corruption: Unethical practices of corporate executives- A case study of Tyco International

Nottingham University Business School

MBA Programme [Business Ethics (N14M15 MY) (SPR 13-14)]

Corruption: Unethical practices of corporate executives- A case study of Tyco International

(Assignment 1: Individual Case Study)

[Racha Zohour Adi]; Student ID: [014132] Original Copy [2] Word Count: 3,030 (Excluding Table of contents, References and Appendix)


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Table of Contents Introduction ............................................................................................................................................ 3 The Scandal ............................................................................................................................................. 3 Crime Uncovered ................................................................................................................................. 4 Ethical Codes Worst Violations ............................................................................................................ 4 Charges ............................................................................................................................................... 5 The Victims .......................................................................................................................................... 5 Where was everyone when this was happening? ................................................................................. 6 Associated Business Ethics Theories ........................................................................................................ 6 Corruption: the …. Bone of the economy ............................................................................................. 6 Morals/Unconscious Psychological Behaviors/Influences Lead To Corruption ...................................... 8 Consequentialism Theory................................................................................................................. 8 Hedonism Theory ............................................................................................................................ 9 Guanxi Mechanism .......................................................................................................................... 9 Deontological Ethics Theory ............................................................................................................. 9 Humanism Theory ........................................................................................................................... 9 Unitarianism Theory ...................................................................................................................... 10 Ethical Relativism model ................................................................................................................ 10 Kant’s Model ................................................................................................................................. 10 Influencing Factors of Behavior.......................................................................................................... 10 Contribution of Corporate Culture to This Unethical Practice ............................................................. 11 During the investigations, it was found that the corporation used “questionable accounting practices”. The upper management was aware and encouraging pushing employees as far as possible to gain earnings for the company even if exaggerated numbers were reported............................................. 11 Organizational Contribution............................................................................................................... 11 The Effects......................................................................................................................................... 13 Conclusion............................................................................................................................................. 13 Annotated Bibliography ......................................................................................................................... 14 Appendix ............................................................................................................................................... 17

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Introduction Understanding how unethical practices of corporate executives happened in the past lead to catastrophic scandals that will affect the successful function of a company, will help executives to avoid them in the future. With that in mind; we will look into one of all-time biggest cases of corruption inside a multinational corporation. Tyco International is one of America’s and the world largest diversified multinational conglomerates with 240,000 employees globally. When former CEO of Tyco (Dennis Kozlowski) joined the company in 1975, the focus of the company was subsequently shifting from growth to profits. He made Tyco reach a position where it became the world second largest medical devices producer and first largest fire and security company and Kozlowski became the secondhighest-paid CEO. The corrupted and unethical behavior in this case study occurred when the CEO & CFO of Tyco were taking unapproved transactions which is basically stealing the company’s money and abusing loan programs of the company. The money was allocated to relocation expenses and taxes for the employees, but was used to have an extravagant lifestyle by the criminals. The crime was caught after years of stealing and put Tyco in the scandal that changed the corporate on all levels, forever.

The Scandal On September 2002, televisions around the world showcased Kozlowski and former Chief Financial Officer (CFO) (Mark H. Swartz) in handcuffs, after being under arrest and accused with stealing more than $170 million from the company and more than $430 million through fraudulent sales of Tyco’s stock and keep concealing this information from shareholders. Former general counsel (Mark A. Belnick) was also charged with concealing $14 million in personal loans. More than 30 counts of ethical misconduct including enterprise corruption, grand larceny and faking business records were charged to the executives. And until months afterwards the initial detentions, lawsuits and charges were still being filed, making the Tyco International scandal one of the greatest notorious of the early 2000s.

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Crime Uncovered During the trial, it has been determined that the two executives (CEO and CFO) worked synonymously to commit the fraud and against shareholders. They ended up getting an equal punishment because of their dual actions in committing their crimes, and by time the dust had settled and 220 of 250 managers got replaced for the reason of not catching the stealing or for allowing this crime to happen. The remaining top 30 managers had resigned afterwards. The crime was majorly uncovered by an attorney from Manhattan district who was inspecting the CEO for evasion of income tax for some purchases of fine art work. As the attorney kept mining and digging through the records of Tyco and its CEO, more suspicious situations has been revealed: $10 million loans completely forgiven by the corporation while all interest got billed to the company’s account. And on January 2002, it was also uncovered that the director (Walsh) had received $10 million transaction for organizing a purchase of CIT group. It was discovered during the trial that the CEO Kozlowski was having an extensively extravagant lifestyle: he owned an apartment in Manhattan worth $03 million, with $6000 shower curtain! His wife birthday party has cost $2.1 million and was held on a Mediterranean island.

Ethical Codes Worst Violations The CEO of Tyco has committed two of the worst violations to ethical codes in this case: 1. He kept lying to the shareholders by telling them he doesn’t sell his stock. He was telling this because he wanted the investors to keep pumping money into the company while he sold his stock. He created a delusion for the investors that he is confident about the investment. While he was turning around and putting his money elsewhere. 2. The other repulsive ethical violation Kozlowski made was his claims of making donations to charity. He kept begging for lenience grounding on the high numbers of money he gave to charity while this money was stolen from others. He used these donations as “tax shield” for his fraudulent operations. His intentions were entirely unethical and he fooled around with people who trusted him for his own personal gain.

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Charges At the end of the trial, the suspects were found guilty for the following: 1. 12 counts of grand larceny 2. Eight counts of first degree falsifying business records 3. One count of fourth degree conspiracy 4. One Martin Act count of securities fraud The major charges for the stealing accounted for $4 multi-million between 1999 and 2001. The charges ascended mainly out of abuse of the “Key Employee Loan Program (KELP)” and the “Relocation Loan Program”. The suspects acquired numerous loans, and then forgave them by calling them "bonuses" although none of the “forgiven loans” were permitted by the board of directors. Those loans were situated to be used for “relocation expenses”, and (KELP) was designed to help key employees to pay their taxes on stock options. And rather than using these loans for this purpose, they were used for living a spendthrift life.

The Victims The only victim in this case is the company. This victim included shareholders, employees and all stakeholders. The whole company has immensely suffered. Stock prices had fallen sharply and the people who were involved had experienced the problems. It affected the investors who trusted the words of the CEO and CFO who indicated that “they did not sell their shares”. When the crime has been uncovered, both criminals sold $100 million of their stock because they knew that the unethical decisions they were making were going to cause the stock price to fall so they didn't want to invest in it. When the stock price did actually fall, the investors -based on the information that they were given by the criminals- which caused them to take bad decisions- have lost their money. The actions of the criminals were not only “ethically irresponsible”, but “socially irresponsible” as well.

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Where was everyone when this was happening? It is unfortunate and disappointing to notice that no individual was playing the role of a “whistleblower”. Unless a group was placed to check deceitfulness and to guard investors, this scandal would be kept concealed for a longer time, it was caught while it’s already spread widely and extensively. If perhaps someone blew the whistle sooner it would help preventing this crime to spread the way it did and have been discovered sooner.

Associated Business Ethics Theories Integrating the unethical behaviors described in this case study with business ethics literature and projecting deliberated theories on the practices that the executives of Tyco international did can provide a richer understating about how to conceptualize and address this ethical dilemma. By questioning the actions in this case, synthesis can be understood: 1. Why business corruption is a major issue that needs much attention from excutives? 2. What are the moral/unconscious psychological behaviors/influences that lead the executives of Tyco to commit these unethical practices? 3. What are Tyco’s cultural and organizational environments that encouraged this behavior? 4. What are the effects of such unethical practices on corporates?

Corruption: Gnawing the Bones of the Economy Corruption and bribery have detrimental consequences on an economy. According to World Bank it is estimated that 0.5% of GDP is lost through corruption each year. Corruption distorts markets and creates “unfair competition”. Corruption unescapably leads to a “diminished business climate” and that’s when the public trust is put at risk. Its presence decreases business credibility and profits, when professionals misuse their positions for “personal gain”. Heavy penalties, jail sentences, and damaged reputations– latest scandals demonstrated what corruption can do to business. Yet it persists.

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A survey by Ernst & Young showed that More than a third of executives felt corruption was getting eviler. Large corporates have huge influences on many public scopes hence its crucial to prevent such practice. An unhealthy business environment can be created by engaging in corrupt behaviors, it encourages unfair advantages and allows systematized crime to flourish. Corruption is one of the key hindrances to the economic development of a country; it demoralizes the role of law, deteriorates trust in public institutes and defies democratic ideologies. Corporates should implement “anti-corruption” policies and practices containing “anticorruption” guidelines, internal audit procedures, training and reporting requirements. It is essential for businesses to review, maintain and develop these procedures to retort to varying circumstances. The below pie charts shows how business executives corruption is the major contributors to a country’s overall corruption and that corruption is the major issue facing countries:

Figure 1: Corruption Sources in Developing Countries Source: http://www.freebalance.com/blog/?p=3473

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Figure 2: result of a survey taken shows that corruption is the major problem facing a country Source: http://harvardpolitics.com/world/fighting-corruption-in-india/

Morals/Unconscious Psychological Behaviors/Influences Lead To Corruption Consequentialism Theory In relation to (John Stuart Mill, 1806-1873) theory about “Utilitarianism” which explains common moralities that drives decision making and describes how an individual must be responsible towards others in business, as towards stakeholders, society and environment. One of the four notions he proposed is (Consequentialism), which means that every action will have a consequence to it. Good consequences are worth struggling for while if there is an action that holds bad consequences then there must be a payment for the action and the person has to live with this decision. Therefore “the outcome of the ethics is based on the consequence”. Apparently the executives of Tyco did not care about the chain of consequences of their actions on stakeholders and the corporation’s success and they insisted on continuing their unethical behavior until they got caught.

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Hedonism Theory The notion “Hedonism” explains the feeling of pleasure and the absence of pain. The executives of this corporation have stolen the company’s money and lived an extravagant life by spending it; they were seeking their own self-indulgence without feeling the pain of guilt or regret. Guanxi Mechanism In the Chinese culture values, “Guanxi” mechanism is an essential and fundamental strategy in business. This mechanism describes the relationships between people or organizations which implicitly indicates assurance, understanding and mutual obligation (Ahmed and Li,1996) but when Guanxi stays in the level of “personal Guanxi”, it might lead to corruption, where the individual will not care about others but only his/her own benefits. This was the case of Tyco’s executives. However, on the other hand and using a similar in concept American term (Country Club) it is noticed that the CEO Kozlowski was treating his people well. He used to throw parties and always commented that the key growth trait of Tyco is the ability to party hard. Deontological Ethics Theory The theory of “Deontological ethics” highlights the fact that there is a “divine entity” that guides the actions of an individual who is creating an ethical judgment. In Tyco’s case, the executives clearly had no higher power involved in their decisions, they operated by their own virtues, they created laws for themselves and follow it; therefore they did not violate their own laws. Humanism Theory On the other hand, Humanism, seem to fit with the executives and the choices they made. Ethics are based on human purpose, perception, or further human characteristics. There is no responsibility for a higher power, hence the subjects are free and open to do things at their own discretion and that’s what they did: they created their own rules, based on their own understanding. Theoretically they did not violate their rules because they were originally corrupt at their very core. It is interesting how during the trial, the CEO Kozlowski showed no regrets for his actions. It is noticed that deep in his conscious he believes that he did not violated his ethical beliefs and

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even though he was convicted by law, he did not admit the wrong unethical decisions he made. He treated the company’s assets as his own assets. His thoughts are clearly directed in the wrong direction and had leveraged the wrong core points and therefor had failed on all levels. Unitarianism Theory Studying this case, it seems that “Unitarianism” is the ethical school that the executives have favored. The CEO has thought that he is doing good deeds by giving money to charity despite the fact that this money is stolen. It is axiomatic that whatever good has been done with the money, it will never change the fact that this money is stolen. Ethical Relativism model By creating his own rules which governed his own ethics, he can be referred to the Ethical Relativism model. He did not regret or see he did anything wrong. He kept feeling innocent. Moreover, Kozlowski acted preemptively when he committed these behaviors because he had the perception that others will do the same to him. Kant’s Model The preemptive behavior may relate to Kant’s model but in a different way. Where it is said that “people should do to others as they would want them to do to them”. On the same opinion with Kantian ethics, “if a person makes an exception to a rule, then that rule applies to everyone else”. In this condition, Kozlowski was obligating himself to an agreement where he was agreeable to be treated that way as well. It was the time to pay humanity when he ordered to pay the fees and sentenced to jail.

Influencing Factors of Behavior Ethical decision making is influenced by individual and situational factors (Rest, 1986). The basic framework model for ethical decision making proposed by Rest also indicated that situational factors like work context or the issue itself plays an important role of taking the decision by an individual. The system of reward, the authority and the culture created has affected the executives in this case as well, putting in mind that the moral intensity is low and moral framing is made by originally corrupted perceptions.

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In the case of the CEO Kozlowski, he was always compared to other leaders. He was under the pressure to keep numbers high and he had a temptation to become the next greatest business leader of all time and at any cost. Kozlowski was indeed a leader to Tyco not a manager, and this made a hurt the company so deeply. He had the loyalty of his employees and he knew how to deal with creating teams and maintaining a family atmosphere. Those factors contributed to him getting away with his practices and going too far with them.

Contribution of Corporate Culture to This Unethical Practice

During the investigations, it was found that the corporation used “questionable accounting practices”. The upper management was aware and encouraging pushing employees as far as possible to gain earnings for the company even if exaggerated numbers were reported. It was also found that the company "suffered from poor documentation; inadequate policies and procedures to prevent the misconduct of senior professionals that occurred; inadequate procedures for proper corporate authorizations; inadequate approval procedures and documentation”. Moreover, in one noted instance in the attorney report, one of the directors had a note to another director that stated, "I would strongly recommend never putting this into writing”. All reporting of Tyco was geared towards gaining profits and scoring high numbers in any possible manner. Only inflated numbers were rewarded but not ethical decisions. Whoever knew playing numbers game got rewarded by cars, allowances, bonuses and gifts. Tyco was “rotten to the core”; numbers had to be significantly twisted in order to be a good player in the game.

Organizational Contribution

According to Edgar Schein’s definition of organizational culture, it is a “pattern of basic assumptions, invented, discovered or developed by a given group as it learns to cope with problems of external adaptation and internal integration”. If it was deemed to work effectively

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it will be considered valid and must be educated to following members as the code of conduct to be perceived The executives and senior management of Tyco were the group inventing those patterns. They established unethical ways to deal with any problems they came across, such as committing fraud, partying and arming managers into acquisitions. These behaviors had defined the culture of the company and whenever managers responded to rough circumstances in an unethical manner, most of the employees did as well. And that was supported and rewarded. This also indicates an “Autocratic” leadership style of upper management where there are two types: reward or punishment. In this case, rewarding style has been demonstrated. Decisions of senior management are strongly connected to how the people perceive the company should behave like. People will do the right thing if senior management did it. And will feel like if they got a “get out of jail free” card if the senior management behaved wrong. It is the culture of the company to behave in this manner, the culture which was created by its senior management. The below diagram describes the how multiple individual and cultural factors can encourage corruption:

Figure 1: Causes of Corruption- Source: http://corruptioncontrol.com/Causes_of_Corruption.html

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The Effects Corruption is a common case amongst corporations which doesn’t make it less wrong. The mentioned case was during a massive wake of corporations’ scandals because government needed to make an example and correct the lawmakers’ images who were receiving bad press about corporates corruptions that needed to be stopped. The media attention was too intense and the scandal went globally shaking the grounds under Tyco and put it facing the urgent need to make the radical management and cultural change. Such cases make any executive who thinks he/she can get away with unethical practices shiver. And the punishment will be applicable on all regardless of their position. Share price of Tyco dropped by 80% in a six-week period. In the days of the scandal the executives escaped their initial hearing due to a mistrial, but they were eventually convicted and sentenced to 25 years in jail.

Conclusion Whatever great business leadership records an executive have, there will always be a need for checks and balances. Transparency should be among all corporate levels and safety measures should be in place to guard the employees from losing their jobs due to fraud. These safeguards can be the whistle-blowers who will contribute in saving the organization. And they should be supported to reach outside the organization as well with no harm for their lives and their families.

Image credit: http://harvardpolitics.com/world/fighting-corruption-in-india/

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Annotated Bibliography 1-Rob Boostrom (2011), Tyco International: Leadership Crisis , Daniels Fund Ethics Initiative, University of New Mexico, http://danielsethics.mgt.unm.edu This material was developed by Rob Boostrom under the direction of John Fraedrich, O.C. Ferrell, and Linda Ferrell. It is provided for the Daniels Fund Ethics Initiative at the University of New Mexico. It provides detailed description of events through the crises timeline beginning with the company’s history then going through the CEO Dennis Kozlowski’s biography before and after the scandal. It also describes how the company had recovered after the crises. There are discussion questions provided at the end of the paper. 2-Investopedia Staff (2011), The Biggest Stock Scams Of All Time, Investopedia US, www.invesopedia.com This page provides a list and brief description of the biggest stock scams similar to Tyco’s case that happened in business history. It is initially designed to educate investors on how stock scams happen and what crises they can result in on shareholders. 3-Transparency International NGO, http://www.transparency.org/ This website is for Transparency International (TI) which is a non-governmental organization that monitors and publicizes corporate and political corruption in international development. It publishes an annual Corruption Perceptions Index, a comparative listing of corruption worldwide. As well as other publishing, surveys and researches related to corruption. The organization defines corruption as “the abuse of entrusted power for private gain which eventually hurts everyone who depends on the integrity of people in a position of authority”. It is a very informative and useful website for all topics related to corruption. 4-Bribery and corruption: Case studies overview – Ashurst, PDF Document available at www.ashurst.com/doc.aspx?id_Resource=4911 This document is published by Ashurst LLP which is a global law firm headquartered in London,

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United Kingdom and a member of the 'Silver Circle' of leading UK law firms. Ashurst is the UK's 7th largest law firm by revenue. It has 24 offices in 14 countries across Asia, Australia, Europe, the Middle East and North America and employs around 1,700 legal advisers. The document provides a very comprehensive and detailed table on bribery and corruption cases happened worldwide since 2001 and up to date. It describes Company, Year, Facts, Charges/ Legislation, Prosecuting Authority, Self-Reporting and Fine/Sentence. 5-Business against corruption, Case stories and examples, Implementation of the 10th United Nations Global Compact Principle against corruption, Birgit Errath of the United Nations Global Compact Office. Published by the United Nations Global Compact Office April 2006 | 2M www.unglobalcompact.org This e-book is a well formatted book which provides comprehensive description of case studies for implementations of frameworks for fighting corruption and lead by United Nations Global Compact Principle. 6-The 10 Worst Corporate Accounting Scandals of All Time (Info Graph) by Accounting Degree Review available at http://www.accounting-degree.org/scandals/ This is a very nice info graph done by Accounting Degree Review website and shows the 10 Worst Corporate Accounting Scandals of All Time based on the following criteria: Company, What happened, Main player, How he did it, How he got caught, Penalties, Fun fact 7-Lea, David, 2004, The imperfect nature of corporate responsibilities to stakeholders, business ethics quarterly. 14(2) 201,217 The author in This paper considers the issue of corporate governance and normative stakeholder theory. He argues that stakeholder theory and responsibilities to non-shareholder constituencies can be made more intelligible by reference to Kant's conception of perfect and imperfect duties. Good reference for theories on business ethics, especially Kant’s. 8-Marianne Jennings, Business Ethics: Case Studies and Selected Readings 2011 The best-selling text of its kind on the market, “business ethics: case studies and selected readings”, 7th edition gets behind the decision-making process of business leaders today to illustrate why good leaders often make questionable decisions. This fascinating collection exposes common themes in less-than-ethical decision making, and shows why leaders make

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ethical compromises in business that they would not make in their personal lives. A combination of short and long cases, readings, hypothetical situations, and current ethical dilemmas, “business ethics: case studies and selected readings” provide students with a stimulating and thorough basis for evaluating business ethics, and encourage stronger values in future business leaders.

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Appendix Persistence of Corruption- Survey Info Graph- Taken By Transparency International Organization

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Corporate Measures against Corruption- Survey Info Graph- Taken By Transparency International Organization

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Corruption: Unethical practices of corporate executives- A case study of Tyco International

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