No Virginia, There Is No Such Thing as Independence
Ethics Resource Center 2003
Independence is a word that is getting a good deal of attention these days but I have yet to encounter a comprehensive discussion of what it means, couched in language that is useful to the typical business decision maker.
As you read the following, it might be helpful to have a context. The Ethics Resource Center routinely advocates for independence. We advise our colleagues and clients that independence is a worthwhile objective and assist them in crafting language to communicate that expectation to their employees and others. We have done likewise with the SEC and US Sentencing Commission. This is not a repudiation of independence. Rather, it is an exposition of our understanding of what it is and isn't in an attempt to move the dialog forward.
In the most general usage independence can be understood as freedom to act without control or influence from others, to be free to make decisions and act without external constraint.
In the business world independence has come to have a specialized meaning. It is most commonly understood to mean freedom from conflicting interests - the specialized case of having the ability to make a decision or act in ways which are free from conflict between one's personal interests and the interests of the party on whose behalf we are making the decision - our organization. The generally accepted definition is further expanded to treat the appearances of conflicting interests as significantly as such conflicts in fact.
Conflicts of interests (or the appearances of same) can take any number of forms. A favorite teaching example gets to what I see as the heart of the issue. Consider the real life case of a General Manager who is looking for a subcontractor to do about $500 million worth of heavy construction work over the next three years.
He creates a committee to craft a request for proposals, identify potential bidders and evaluate submitted proposals. His instructions to the committee include a set of objective criteria for judging bids and a request that the committee narrow the field to what they believe are the best 1-3 bidders.
At this point, when asked, most groups agree that the process is "fine" so far.
The committee does what they are asked and comes back to the GM with two prime candidates for the contract - Company A and Company B. He thanks them for their work and explains that he will contact each company and hear their presentations then make a choice.
He hears each company's pitch and makes a choice. Company A wins the bid - Company B is thanked for their efforts and is encouraged to bid again next cycle - they were a legitimate contender.
So far, so good? At this point some people have concerns about the process but most agree that the decision appears to be on the up and up.
Three months later, the GM resigns his position and takes a job with Company A as VP in charge of Business Development at an annual salary of $350,000 - about twice what he was making before. And at this point in the story opinions change. This now "smells bad." Everyone agrees there is something wrong here.
What is wrong is that there is now reason to believe that the decision to select Company A COULD HAVE BEEN influenced by the promise of future employment. This is a classic example of the appearance of a conflict of interest. We have no data to prove that a quid pro quo deal was made but most reasonable people would agree that it looks like such a deal could have been made. The decision is tainted by the notion that the GM might have chosen Company A for personal reasons - the promise of future employment - rather than merit, that they were the better company.
With this example as background, let's examine independence as it applies to business decision-making. The GM in our story was not free to act without external control or influence if Company A offered him any "inducement" to select them other than a demonstration that they better met the criteria set out for the selection of a contractor. His freedom to act without control or influence from others was compromised if and when Company A offered him a personal gain if they were selected.
But was he ever really independent?
Can Independence Be Absolute?
Consider the broadest argument regarding independence. Independence cannot ever be absolute because any decision is made in a societal context and society has standards and expectations. Society imposes constraints; thus, independence is never an absolute. Our independence is limited by what society deems reasonable - by the values and principles, which define "appropriate." Thus we can understand independence not as the freedom to do whatever we want, but rather freedom to do what we ought. We are free to act in ways that are consistent with society's definition of what is right or best.
Let's narrow the argument to discuss conflicts of interest specifically. One could argue (in fact I do argue) that every business decision any employee makes is conflicted - is subject to the external influence of potential personal gain. If I am an employee and choose to do "X" - anything at all - and my sole basis for choosing X is that it is the very best thing to do for the company, am I free from conflict or the appearances of conflict?
Perhaps not. If it is good for the company and I am an employee doesn't that improve the odds that it is good for me too? If the decision makes the company more profitable, safer, more efficient, better respected, more successful by any measure, than I may be recognized as having contributed to that success. I might get a better performance review, a promotion or simply acknowledgment from my boss that I did well. Or, minimally, I might not get fired, laid off, demoted or ignored quite as much.
Sanford Krolick in his Ethical Decision Making Style Survey suggested there are four sets of criteria, which are considered every time any employee (at any level - up to and including members of the Board) considers a business action or makes a business decision. To paraphrase Krolick:
- Pragmatic considerations: what are the business consequences of this action or decision?
- Altruistic considerations: What impact will this action or decision have on others or my relationship with them?
- Idealistic considerations: What is the right thing to do - as defined by the values and principles, which apply to this situation?
- Individualistic considerations: What will happen to me as a consequence of this action or decision?
If we focus for the moment on individualism, we can explain the philosophical position that it is difficult (perhaps impossible) to consider any act of pragmatism, altruism or idealism as "pure" - 100% of the motive behind a decision.
For example, the argument states that no act is 100% altruistic because the person acting gets some personal benefit from the act. An unselfish act of doing for others leaves a residue of satisfaction, joy, or comfort in the person committing the act. A similar claim could be made that there is an individualistic element in any act of idealism or pragmatism.
If this is an accurate description of human psychology, and I believe it is, then we cannot escape the reality that every pragmatic, altruistic or idealistic action and decision has the potential for personal impact. Therefore absolute independence (e.g., 100% pragmatism untainted by individualism) is a myth. An aside, please note that this is not to suggest that individualism is bad. When personal goals are congruent with idealism, pragmatism and altruism, one's resolve to do the right thing is strengthened. This is not an argument against individualism, but rather, the recognition that individualism cannot (and likely should not) be eliminated from our decision making process.
What Do We Really Mean When We Talk About Independence?
If we agree that absolute independence is unattainable, then what are we left with as an ideal? Perhaps we can merely hope that the preponderance of the influence will be for the greater good and that we will consciously work to recognize and minimize the individualistic considerations as we make our decisions.
In the news recently we have heard about the need for Boards of Directors' to address concerns about the lack of independence of their members. If absolute independence is unattainable, what should we demand of our decisions makers - employees, executives and Boards?
I propose that the most to which we can aspire is good faith. After all, it is not independence we are really wanting - it is that the decision-maker subordinate the individualistic considerations to the pragmatic, the altruistic and idealistic
The expectation of 100% independence in a Board member's decision making is unrealistic. A good faith effort to meet the fiduciary obligations of the position calls for pragmatism, altruism and idealism to dominate and for individualism to be subordinated
There are also situations where the expectation that individualistic considerations can be minimized would be unrealistic. Consider the earlier example. If the GM had in fact been offered a lucrative position for selecting Company A, it would have been most difficult for him to keep that offer out of his considerations. Even had he been desperately trying to keep the offer from influencing his choices his own psychology would have been working against him.
The problem is our facility with a psychological process known as rationalization. Simply described, rationalizations are lies we tell ourselves to give us permission to do what we know is wrong. We recognize the most common rationalizations for what they are when others use them:
- No one will be hurt. (Or the variation, "No harm, no foul.")
- No one will ever know.
- If I don't somebody else will. (Or its companion, "Everybody else does it.")
But even when we recognize rationalizations like these, we do not necessarily disempower them. Key decision makers need to act so as to prevent their use of rationalizations - and that is not necessarily a natural act. It requires an external influence to ensure that even the highest-minded of us will subordinate our individualistic interests if the stakes are attractive enough and our powers of rationalization well developed enough.
Perhaps a first step in the direction of creating a workable external influence is transparency. The remedy for conflicts of interest in most situations is as simple as disclosure. Laws and regulations may impose disclosure, e.g., financial disclosure requirements for elected and appointed government officials. Policy and procedure may do likewise for employees, executive officers and Board members of large corporations, e.g., disclosure of financial holdings and interests in competitors, suppliers or other key stakeholders.
So, if the disclosure remedy is already in place, why the current problems with conflicts of interest and the apparent lack of independence? Perhaps it is because the process is viewed by many of those subjected to it as both passive and voluntary.
"I will answer the questions as asked. I will disclose what I am required to disclose in my annual reporting. I will comply with the letter of the law but may lose sight of the spirit of the law because it is in my self-interest to do so and as discussed above, I can never free myself from the inherent need to serve my own self interests - after all, that is my nature."
Part of the remedy might be to make disclosure of conflicts, potential conflicts and situations that might create the appearance of such conflicts proactive. If with every vote of the Board each member is required to affirmatively reveal any and all real or potential conflicts, no matter how minute, and allow his/her colleagues to rule on their significance, then perhaps we have made the process more independent.
Transparency ought not wait on the individual to volunteer conflicted interests. If we acknowledge that there is at least a modicum of conflict in every decision, then let's change the standard to a mandatory, full and public accounting of those conflicts for each decision.
But, What Of Privacy?
What about individual privacy? I suggest that society cannot afford to allow Directors the full extent of privacy they have grown accustomed to. Just as public officials must withstand public scrutiny before being allowed to serve, so too should members of Boards of Directors. Part of the due diligence of selecting Directors should be the full documentation of the candidate's financial holdings for the purpose of surfacing potential conflicts. Further, each Director must affirmatively state that he/she has no significant conflicts each time a decision is made.
Alternatively, if there is a conflict or the potential that such a conflict would be perceived, each Director is affirmatively obligated to raise that concern as soon as it becomes apparent in the discussion or decision-making process and allow the Board as a whole to rule whether that concern warrants the Director's recusal from the process.
The affirmations of freedom from conflicts and the disclosures of potential conflicts become part of the minutes of the meeting and are a permanent record of the proceedings. And those minutes can become matters of public record if the public's interest so warrants (e.g. subpoenaed in the event of a legal proceeding)
This is an imposing requirement and will certainly slow and possibly impede the conduct of the Board's business. It is not put forward as the ideal process, but rather as an example of the desired outcome - full disclosure of real and potential conflicts of interest within Boards of Directors - in recognition of the fact that independence is a myth and cannot be assured in advance of Director selection.
What About Auditors?
Much of the public discussion has been focused on the special need for independence of auditors. The concern is that auditors seem to have multiple motives for their actions beyond the accurate determination of the financial standing and reporting of the firm being audited. The fundamental question would seem to be, "Is independence any more realistic as a requirement for auditors than it is as a requirement for Directors?" I propose that the answer must be a resounding "No!"
If that is correct, then what process might we implement to protect society from the individualism of auditors? Absolute independence is unattainable for all the reasons discussed above. So what is available to society as a standard for auditors?
At the risk of seeming simplistic, transparency might again be the proper standard. As part of their published findings, auditors might be required to reveal all transactions and conditions surrounding their relationship with the audited organization that reveal either real or potentially perceived conflicts of interest. As with Directors, this should be proactive and ongoing throughout the audit process and should address conflicts both for the individual auditors and the firm that employs them.
Society, armed with this information can judge its significance, the propriety of the auditor and the trustworthiness of the audit.
This should not be limited to financial auditing. Many organizations engage in various non-financial audits: social audits, safety audits, security audits, quality audits, environmental audits and even ethics/integrity audits - and the presence of individualism-driven conflicts of interest is just as prevalent. In the corporation where I once served as a line manager the safety auditor was quite candid - he had to find a certain minimum number of defects/violations or else he was certain his management would deem him ineffective. The integrity auditor reported the same reality as did the OSHA inspector. The premise they believed to be in force was that if one is paid to find discrepancies and one fails to find them when they are expected, the fault must lie with the examiner
Transparency, fully and proactively applied, can serve these functions in much the same way it can serve financial audits and the deliberations of Boards.
I suggest it is time that we take three bold steps.
1. Acknowledge that independence is an unrealizable ideal since conflicts of interest are inevitable - individualism cannot be removed from the equation
2. Replace the unrealistic demand for independence with a more realistic demand for transparency - the open acknowledgement of real and potentially perceived conflicts of interest, large and small.
3. Hold each Board accountable for the proactive disclosure and the appropriate resolution of all of the conflicts it faces
Finally, as was stated above, this is proposed not as a resolution of the issue but as a stimulus to discussion. What preceded was an attempt at moving the dialog forward.
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