C449 B7 C4d01

Recognising Value Based Approach In Corporate
Governance : Institutionalization Of Ethics

Zaleha Othman* and Rashidah Abd Rahman**

Corporate governance is the structure used to direct and manage
the business and affairs of the company towards enhancing
business prosperity and corporate accountability. However, for
decade argument on the inadequacy of corporate governance
mechanism to cope with the modern corporation seem to hit the
business agenda. Several views indicate that the principle based
governance designed to direct and manage business could not
cope with the globalization era of business. The purpose of this
paper is to propose fundamental element to fill the inadequacy -
incorporating value based approach into corporate governance
practices. This paper argues that value based approach form of
corporate governance practices need to be introduced to support
the present corporate governance practices framework. Hence,
this paper will discuss the ethics aspects of governance focusing on
formalization of ethics in organization as a mechanism to improve
governance practices. A single case study was conducted to
explore the ethical mechanisms that have been institutionalized in
order to enhance corporate governance practices. Interview was
performed with relevant key person in the company. Based on the
interview conducted several ethical mechanism were discovered in
order to enhance better governance in the corporation. This paper
contributes towards new perspective of governance whereby the
ethical aspects is integrated into the governance practices.

Field of research: ethics, corporate governance

___________________________

* Zaleha Othman, College of Business, University Utara Malaysia, Malaysia email: zaleha@uum.edu.my

** Prof. Rashidah Abd Rahman, Faculty of Accountancy, University Technology MARA, Malaysia email:
shidah@salam.uitm.edu.my

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1. Introduction

Corporate governance is a topic which is often discussed and debated upon in recent
years. Although the issue of corporate governance has been discussed since the early
days of corporations, the interest on corporate governance seems to take the attention
of the media and the public after the giant corporate scandals such as Enron, Worldcom
etc. Due to its economic impact, these corporate malpractices spark the crisis of trust
among the stakeholders. Subsequently, realising the important of governance issues,
regulators in various countries including Malaysia provides various perspectives for
governance reforms. As a moved to rebuild the trust on the governance systems
initiative on improving the corporate governance systems has been formulated world
wide. Proactive measures have been taken by the regulators to put forward
recommendations and regulations on corporate governance. Continuous efforts
developed simply to guide corporations into achieving necessary high standards of
corporate behavior.

However, the trend of corporate scandals keep emerging which questions the credibility
of our corporate governance system. Some claims that the present corporate
governance mechanism neglect fundamental element (Coffee, 2003). Reviewing the
literatures, it is also noted that the current corporate governance mechanism has its
limitation. The purpose of this paper is to propose fundamental element to fill the
limitation - incorporating value based approach into corporate governance practices.
This paper argues that value based approach form of corporate governance practices
need to be introduced to support the present corporate governance practices
framework. Value based approach is necessary to cope with the advancement of
business conduct in this era. Hence, this paper will discuss the ethics aspects of
governance focusing on formalization of ethics in organization as a mechanism to
improve governance practices. A single case study was conducted to explore the
ethical instrument that have been institutionalized in order to enhance corporate
governance practices. Hence, this paper will discussed on the various ethical instrument
present in the company selected. In essence, this paper contribute towards
advancement of knowledge in governance as it put forward the important element (that
is ethics), which is recognized as fundamental to circumvent corporate governance
flaws by several researchers (Arjon, 2005; MacKenzie, 2004, Oon, 2004)

2. Literature Review

Concentration on corporate governance mainly dealt in the decision making of board.
Implementation of the decision making is indeed important as the decision by the board
involves the strategic planning of the whole corporations. Hence, accomplishing the four
pillar of corporate governance that is accountability, transparency, fairness and
responsibilities are core values in every decision making in a corporations. Good
governance as described by Quinsumbing (2007) is formal and informal decision

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making and the process of which the decision is made. Therefore, good governance
possess characteristic such as participatory, consensus oriented, accountable,
transparent, responsive, effective, and efficient, inclusive and follow the rule of law
(Quinsumbing, 2007). The key challenges of modern corporations, however is to
accomplish these values at the same time maintain the sustainability of the
corporations.

Compliance based approach of governance structure have been claim insufficient in
coping with the challenges of modern business (Arjoon, 2005), hence companies find
themselves pressured to satisfy stakeholders demand for accountability and
transparency. Typified by the agency theory where the wealth of stakeholders is made
priority has somewhat incapacitated the compliance based approach of corporate
governance. Profit driven motivation of achieving the wealth for stakeholders is no
more relevant in sustaining the growth of business in the globalization era. Globalization
has forced corporations to act ethically or confront with the consequences of losing their
support from stakeholders.

Bring to the fore, integrating ethics as a new approach towards better governance has
been viewed important. This is due to the many suggestions made by governance
scholars that ethics is the core concept in corporate governance (e.g Cladwell & Karri,
2005; Sullivan & Shkolnikov, 2007). Businesses have responsibility towards the society,
therefore answerable to the society. As emphasised by the social institution theory, a
corporation is not merely a private association created for the purpose of personal
enrichment but also a public enterprise that is intended to serve some larger social good
(McEwan, 2001). Hence, ethical behavior is the social responsibility of a corporations to
protect the society in which they operate (Fisher, 2004). Fisher (2004) further adds that
the responsibility of corporation is a set of obligations the corporations has to protect in
a society in which they function.

Several opinion has been gathered to claim that integrating ethics value in an
organization could prevent corporate mishap and thus safeguard the individual and
corporate reputations (Drennan, 2004). Infusion of ethics principles and values into
corporate culture often been emerged in the boardroom discussion. Fombrun and Foss
(2004) highlight the three principles which has often emerged in the discussion among
the board are: infusion of ethic principles and values into corporate culture, appointment
of chief ethics officers, adoption of stricter ethical guidelines and codes of conduct.

2.1 Institutionalized Of Ethics

One of the views of infusing value based approach of governance is through
instiutionalisation of ethics. Several ethic researcher claims that institutionalization of
ethics is a formal initiatives to guide the member of an organization in making ethical
decision (Weber, 1981; Hoffman, Moore & Fedo, 1983). Empirical evidence in the
1980’s and 1990’s has proven on the point that institutionalization of ethics is a form
that have been incorporate in organization to direct corporations towards ethical
decision making. (i.e Stevens, 1994; Vitell and Hidalgo, 2006). But what is

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institutionalization of ethics? There are several views on the understanding of
institutionalization of ethics. Andrew (1989), for example, defined institutionalization of
ethics as the action that are needed to map a high road to economic and ethical
performance and to mount guardrails to keep corporate wayfarers on track’ (p.99 as
cited in Soutar, McNeil & Molster, 1995). Purcell and Weber (1976: 6), on the other
hand, defined it as
‘… institutionalizing ethics may sound ponderous, but its meaning is
straightforward. It means getting ethics formally and explicitly into daily
business life. It means getting ethics into company policy formation at the
board and top management levels and through a formal code, getting
ethics into all daily decision making and work practices down the line, at
all levels of employment. It means grafting a new branch on the corporate
decision tree- a branch that reads ‘’right/ wrong’ .

Purcell and Weber (1979) suggested that companies should adopted institutionalization
of ethics to impose good strategy in companies. Recent opinion on institutionalization of
ethics has been viewed in Vitell and Hidalgo (2006) where, it has been identify as an
important route to control the problem of ethical issues in an organizations.
Institutionalization of ethics explores how organization structure and action are molded
by cultural, political and social forces that surround the entity (Fogarty, 1995). This
organization structure and action are important as the action which does not instill with
values, may lose the support of the institutions actors. This is because, the environment
surrounded the organizations dictate that organizational survival is predicated upon
some form of conformity to prevailing values or standards for appropriate behavior. As
pointed by Fogarty (1995), institutional theory provides an ability to allow for the
separation of the rhetoric of ethics and ethical action.

Soutar et al. (1995) explained that institutionalization of ethics keeps the employees of
an organization guided by formal ethics element to matters relate with ethical concerns.
This formal guidelines is indeed important as has been noted in McEwan (2001) that
ethics is an important element in decision making process in an organization.
Institutionalization of ethics would helped in decision making in an organization because
it is a form of consistent set of value that would guide employees in their conduct of
doing business. Soutar et al. (1995) in their study reveal that there are three factors to
institutionalized ethics in an organization which are: internalization of ethical values,
compliance with rules, and external perceptions. In their study of institutionalization of
ethics in Western Australia Stock Exchange companies listed in main and second
board, Soutar et al. (1995) found that forty eight percent of these listed companies have
institutionalize ethics in their workplace. As for the factor contribute to companies
taken formal step to incorporate ethics values, it is reveal in their study that size is a
factor that explain the interest to institutionalize ethics in these public listed companies.
Larger companies (with employees between 1000-5000) have formally incorporate
ethics however, the smaller companies (less than 100 employees) had undertaken the
initiatives. Sourtar et al. (1995) also found that there are several reasons for companies
not taken initiatives to institutionalized ethics in their organization process, which are
company is ethical enough, company too small to need it, lack of time to plan such
efforts, and lack of financial resources. It is also discovered that the major pushing

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factors are more of external purposes as the main reason was to provide direction to
employees and to be seen as socially responsible and to improve corporate image.
Nevertheless, the internal pushing factor describes are improving management
behavior and corporate culture, compliance with law and the reduction of criminal
activity in the workplace.

Sims (1991) in his suggestion described several elements which could be
institutionalized within organizations. Permanent board-level committee, code of ethics,
ethics training are some of the ways to institutionalized ethics in an organization apart
from managing the psychological contract between its employees and the
organizations, reinforcing the employee’s organizational commitment, and encouraging
an ethically-oriented organizational culture. In addition, Jose and Thibodeaux (1999)
conducted a study of 86 corporate level marketing and human resources managers of
American multi-national corporations. It found that the implicit forms of institutionalizing
ethics is more effective that the explicit forms in shaping the ethical behavior.

It is also revealed that institutionalization of ethics such as ethical program could
provide difference in governance practices in a corporation. Felo (2001), for example,
although found that there is no significant relation between the potential conflict
corporate governance structures in firms with ethics program and without ethic
programs, however firms in which board are actively involved in the oversight of the
programs have more independent boards than firms which the board are not involved in
the programs. As a matter of fact, recent study conducted by integrity interactive
Europe concluded that robust ethics and compliance program are the major concern for
business across Europe. Implementing ethics and compliance programs are among the
top reason chosen by the heads of legal and chief compliance offices of 500 largest
companies for doing the right thing and building common company culture. Needless to
say, the trend of institutionalization of ethics continues as companies realize the
benefits of infusing ethics in business activities. Companies take initiatives to include
and improvise the ethical mechanism to attract particular interest group towards the
companies as it is belief being a responsible member is rewarding.
Following section of the paper explains the outcome of a case study conducted by the
researcher to investigate the mehcanism used for institutionalizing of ethics in
enhancing corporate governance practices.

3. Research Method

A single exploratory case study was conducted for the purpose of exploring the ethics
mechanism institutionalization in company to enhance the practices of good
governance. The case was selected based on certain criteria such as suitability of
company being listed in the public listed companies. Also, it is listed among the best ten
companies which are ranked to obtain high corporate governance score in 2006, hence
appropriate to be selected as sample for the study. As stated by Ritchie and Lewis
(2003), unit for sample chosen due to the characteristic that is expected or known to
have salience to the subject matter under study, in other words, ‘symbolic
representation’ due to its relevant to the investigation of the study.

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3.1 Description Of The Case

The description of the case is restricted for the purpose of confidentiality. Hence, the
name of the company would not be disclosed. However, basic information of the study
will be described. The study was conducted in one of the leading communication
corporations in Malaysia. It started as a private company but has been listed in the
Bursa Malaysia for several years. The company is well established for its innovative
service provider and has received several domestic and international awards. This
company grew rapidly due to the demand of communication technology. The selection
of the company was based on the criteria that the company is among the top ten (out of
350 companies listed on the Main Board) that had been accounted as companies
practicing the highest level of corporate governance compliance in accordance with the
Bursa Malaysia Securities Berhad corporate governance and best principle. The rank
on the level of compliance was based a joint study by the University of Nottingham and
the Malaysian Shareholder Watchdog Group (2007) related with corporate governance.

3.2 Design Of Research
An exploratory case study is appropriate to describe the research strategy. The
exploratory fits in the design because at this stage, this study mainly focus on ‘what’
questions which as described by (Yin, 1994) justify the rationale for conducting an
exploratory study. In this sense, the present study aims at exploring ‘what’ and ‘how’ the
company use ethical mechanism that could enhance its corporate governance
practices. In order to answer the inquiry: what are the instrument used to incalculate
ethical conduct in improving corporate governance practices, the research procedure
follow the inquiry method. Discovering what is the ‘truth’ out there is the key issue of
the research design. Hence, based on the nature of the study (i.e exploration of ethics),
face to face interview is appropriate technique. Interview was conducted with the head
of internal auditor. The head of internal auditor was selected due to his scope of work
where any ethical issue and concerns is the responsibility in his unit. The interview was
recorded on tape, but in some cases notes were taken. The tape was subsequently
transcribed. Documents such as the annual report was also observe to investigate the
aim of the study. Themes were then identified from the transcription, document analysis
and a summary of result drafted.

4. Findings and Discussion

Based on the interview transcribed, several themes related with institutionalization of
ethics as being possibly influencing the corporate governance practices were
discovered. Some of the themes are directly concerned with the formal structure of the
company whilst others are more of views of the respondent. Based on the data
gathered, the data were later broken into themes. These themes are:

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4.1 Committees And Committee Members

The respondent pointed several ethics structure that is practiced in the company. One
of the main initiatives towards good governance practices is that the company form
“Defalcation Committee”. It is a committee that set up to deliberate all conflict cases
related with ethical issues. The members of “Defalcation Committee” are the Chief
Finance Officer, Director of Human Resource, General Council and Chief Operating
Officer. The purpose of forming this committee is to listen and make decision upon any
individual who had violate the ethical conduct based on the report made by the Internal
Audit Department. Disciplinary act will be taken upon the individual based of severity of
the cases which has been brought on by the Internal Audit investigation and report.
This committee will meet once in every six weeks to update on the cases reported by
the Internal Audit Department. The decision of ‘Defalcation Committee” is taken
seriously by the company.

4.2 Criteria Of Director Appointment

Another means of enhancing good governance is setting criteria for appointment of
directors. The respondent pointed to additional criteria for selection of directors where
the criteria for appointment of director should be beyond their qualification. He strongly
believed that directors of a corporation should not be restricted to skills and knowledge.
Malaysian Code of Corporate Governance (Report on Malaysia Code of Corporate
Governance, 1999) recommended that board should make up of combination of
directors who has intimate knowledge of the business. However, the Code does not
emphasis that the credibility of board members in terms of their recognized integrity and
credibility. The company however, emphasize additional criteria which he find important
in enhancing standard of corporate governance practices. Apart from directors skills and
knowledge, the persons appointment should be of high reputation and integrity. As
mentioned by him, this criterion is applied in the company understudy. Selection of
directors for the said company is based on their reputation and integrity stand point. He
explained the credibility of all twelve members of the board. Majority of the board
members had experience in prestigious international companies with high business
reputation. The board of director line up are mainly persons with high integrity and re-
known business person. He also states that Malaysia has long way to go in terms of
the board members reputation and contribution towards the governance practices as
Malaysian environment may be dominated by the founder and family which probably not
in the position to contribute the best to the business. He stress that shareholders
should be more vocal in terms of selection of directors.

4.3 Promotion Of Ethics

There are various ways that are practiced in the company in order to promote ethical
conduct among the staff, board members and employees of the company. Below are
several ethical instrument that are gathered based on the interview.

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4.3.1 Code of conduct and business practices

“Ethics is core value of the company, on top of company satisfaction and culture”;
statement pointed by the respondent. Ethics is one value that is considered as a
core practiced in promoting and communicating good behavior in the company.
He voiced that the company do not tolerate unethical behavior with any parties
related to the company. The key manifesto of the company is to operate its
business fairly, ethically and in full compliance with all laws and regulations. In
order to make belief the manifesto, the company has created a detailed Code of
Business Practices guideline for all the relevant internal and external parties.
This Code of Business stipulates how each relevant individual should react and
behave in line with the expectation of the company good governance practices.
For example, every employee of the company must reach understand and sign
the code of business practice every year, this more than 10 pages document that
lay down precisely what company standard for, regard to principle of ethics,
down to the detail of what given or gift, that they can receive and not receive or
procurement and delivery with contractor or member of the staff. Those are being
sign once a year to remind people of values. The practices in not restricted to
employee, as a matter of fact, other relevant parties involved in the company are
also bound by their ethics instrument. The company also formulated a vendors
code of business practices. The vendor codes consist of practices that are
expected from vendors and the guidelines that are formulate by the company in
order to main certain standard of integrity from both parties (the company and the
vendor). “All company doing business must also signed on code of business
practice, where they seek to communicate our principal of doing business and
they are written reading and acknowledging they are being understand. Vendor
who found to be working against this ethics, would be discontinued from doing
business with us”. This explained by the respondent is the entry point code of
business proactive.

In regards to the implementation and effectiveness of the code, the company has
specially established office of Business Practices to provide policy guidance and
facilitate compliance with the code. Continuously efforts are taken by the office of
Business Practice to look into ways to enhance high standard of business
conduct and ethics in the company such as benchmark for best practices is
observed to further improvise the company business practices.

4.3.2 Ethics Hot line

Further instrument disclosed by the respondent in promoting ethics is that the
company created ethics hotline. In order to maintain the integrity of the hotline
and the confidentiality of the subject, an independent unit is mandated to hold the
trust of the hotline. Hence, internal audit, being the internal independent
department is the custodian of the hotline. The purpose of appointing internal
audit unit as custodian is because the staff would have higher confident to report
through email or letter of any wrong doing instead of directly report to the top

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management. Staff in this company normally have full confident to report to the
internal audit without fear.

4.3.3 Other sources

We have internal control web whereby all employee can get access. It is a
program on internal control, case study and part of ethics. The is a section called
“ask dr control’ where the employee can ask any enquiry related to internal
control, risk management and any ethics issue. That is one training using virtual
reality that is easily accessible and provide quick answer for the employee to
resolve their conflict or query related to ethical issue. In addition, on entry point,
every new staff is given training related to ethical conflict. Thus, would guide
them to deal with ethical problem or issues in future. Some of the staff such as
the management manager and the engineer were given training in a
management attachment program where they are trained from six to twelfth
month. This attachment program nurture them to be ethical manager and be
better in internal control.

4.4 Behavioral Development
Employees are constantly encouraged to attend programme such as ‘effective people
program’. Such programmes are developed to enhance their management skill. The
company provide change programme initiatives to facilitate the mindset and behavioral
change to realize the company long term vision target. The aim of establishing the
change programme is to established the company reputation and to sustain the
company value proposition. The company also revamped their performance appraisal
system to incorporate performance indicator on behavior al mindset change. This is a
good move made by the company to instill good behavior among employees in ensuring
continuous permeation of the culture across all aspects of the company business.

4.5 Leadership Extract The Culture
The respondent viewed that the company is run professionally as the leaders are of
professional managers. He explained each individual senior board team with great
admiration. Observing the members description, the quality of board members is
disputable as their various background, culture and nationality of the board members
indicate the professionalism of the company. This is an advantage of the company to
possess mix talent from outside and within Malaysia. As mentioned by the respondent,
all of the board members have a good track record. They are highly regarded individual
in the business society. Majority are from reputable multi national corporations. As
stressed by him, “basically we get the best people around. Their background is strong
so when they go to board meeting they can contribute”. The respondent voiced that
the corporate governance survey on disclosure of best practices although good, has its
limitation. This is because the measurement does not measure the internal part of the
company for example the reputation of the leaders. He foresee that the missing element
which is very important for investors is not disclosed in the Annual Report. The missing

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element could not be prescribed in the statement of corporate governance but culturally
cultivate by the leaders in the company. It has strong business fundamental and culture
of innovation. Highly qualified individual are trusted to carry out this culture of
innovation. What they stand for? Who represent the leadership? Who are they?
Observing the annual report, the company provides quite an extensive description of
each individual board members including their experience. The board shows good
example to the employee by themselves attending training programmes such as in-
house to develop their leadership qualities and managerial capabilities.

4.6 Internal Ethics Policy

The procedure related to ethical concerns especially business conduct such as
receiving gifts are well documented in the company. For example, they have a
declaration form to be filled in for anyone who received gift worth more than RM200.
The application will be approved by an ethics officers who will decide on whether the gift
should be returned or otherwise.

4.7 Formalised Communication
The company also believe in communicating ethics values from top to bottom. This is
done through program where the code in business practice is communicated to the
staff. How this is done? Every new recruits to this company spend first week in
orientation program where the code in business practice is explained. The objective of
the program is to ensure new recruits understand the practices of business conduct in
the company and respect the expectation of the company towards ethical behavior. In
order to bind their responsibility, accountability and duties, the recruits have to sign
code of business practice in their first week of employment.

Another form of communicating ethics is through means of disclosure of cases of wrong
doing occurred in the company. In order to maintain ethic as core value practice in the
company, the company communicate formally to the employee by verbally or formally
inform them of the misconduct that has happened in the company.

“Every years I summarie all the investigation and communicated this with the
staff verbally and in the Internal audit control bulletin. I publish this and tell the
staff during the year and investigation 14 cases in a year. These cases are like
falsification of documents, breach of document practices. As a result of the
investigation 10 people has left while 6 dismissed the discipline letter”.

Punishment for those who violate the ethical stance of the company is a message to the
others that the company practice high standard of ethical conduct.

4.8 Internal Audit Involvement
Internal audit department in the company plays a key role in the institutionalization of
ethics towards good governance. The internal audit department educate through

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various means in order to teach the staff with several tips of wrong doing such as
recognizing red flag. Unlike other internal audit department in other company, the board
recognized the important role of internal audit in enhancing ethical behavior among
employees and enhancing governance practices in the company. Internal audit
department in the company is very active not only in investigation but managing
corporate governance and internal control issue. As a matter of fact, the head of audit
is the member of the senior management team to ensure good corporate.

4.9 Enforcement

Implementation is an important aspect in ensuring best practices. ‘Walk the talk’ is a
motto that should be practice in any organization. Essential to maintain the business
reputation, the company formatted several strategies to ensure that good governance
practices. Defalcation Committee is one initiate taken by the company deal with
regulatory on matters pertaining to fraud and unethical practices. The Committee works
with Internal Audit Department and Management to act upon any cases of wrong doing.
Hence, appropriate action are taken up by the committee upon the findings of the
investigation. A fraud management function is also formed to safeguard the interest of
the customers. Fraud management function is a monitoring unit that monitor the daily
subscriber call pattern to recognize suspected call fraud which uses the industry
development system to detect such wrong doing activities. Remedial action are taken
proposed to the management to ensure enforcement are taken seriously regarding any
unethical behavior to protect the interest in this case the stakeholders.

5. Conclusion

It is about time that corporate governance framework consider to include reference to
business ethics. For two decades the present corporate governance framework has
guide businesses towards compliance based approach. However, the present corporate
governance framework has over time shows its limitation towards the business in this
era. Empirical evidence gathered based on a single case study explored found that
institutionalization of ethics in the corporate governance practices structure would
contribute towards different spectrum of governance. The study which explored how
ethics concerns can be integrated in the corporate governance structure in an
organization provide new insight of governance. Ethics instruments that have been
formalized would help to implement high standards of governance in a corporation.
Such approach provides evidence of the corporation commitment to good corporate
governance practices. Further study need to be undertaken using a different approach
to establish the relationship between the ethical variables and corporate governance
practices.

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