Abu Dhabi, UAETuesday 21 May 2019

Sabah al-Binali: your guide to handling ethical management issues

The best ways to deal with difficult situations

Jawbone in 2012 released redesigned fitness devices such as its UP wristband but still went into liquidation. Nicholas Kamm / AFP
Jawbone in 2012 released redesigned fitness devices such as its UP wristband but still went into liquidation. Nicholas Kamm / AFP

You have spent a lot of time honing your business ethics, governance and compliance skills, but time and again you find yourself in difficult situations and realise nobody taught you what to do.

If I just described you, then this article is for you.

Most of what is taught is with regards to how to act if we initiate an action and, possibly, how to react when a client initiates an action. What I have not seen taught is how to react if your manager initiates an action. In this case there are broadly two scenarios: First, it is a legal and ethical instruction; or second, it is an illegal or unethical instruction. In the first case the employee’s proscribed reaction is straightforward – execute. In the second case it is to not execute the instruction. But is that as simple as saying “no”? Of course not.

Even in relatively flat/informal organisational structures, this is difficult. When the hierarchies are formal, prized and inflexible it is next to impossible to refuse an illegal instruction. Without clear wrongful termination and whistleblower laws it becomes extremely difficult for an employee to stick to their values, especially in the current climate, as the consequences can quite easily lead to personal insolvency. For foreigners the risk is greater still; if the employee is fired in retaliation they have three months to find another job or face uprooting their entire lives, family and all. A daunting risk to doing the right thing.

So how does one manage such a situation? For the cases when legal lines are crossed I will defer to those with a legal background. When it is an ethical issue there are alternatives. I will focus on cases of wilful wrongdoing.

The most potent tool for the employee with integrity is documentation. Closely following that is witnesses.

Documentation works in two basic ways. The simplest is requesting that any instruction be given in writing. This rarely works as it is transparent to the dishonest and they will not only avoid it, they will retaliate. There is a workaround via the use of written communications, eg emails, for clarifications or status updates.

For example, if given a verbal unethical instruction one can follow up thereafter with a clarifying question via email. It is important to phrase the email in a way that does not stop the process. So let’s say one is asked verbally to transfer US$152,455 to an external account. Sending an email asking if this is the correct number creates a bind, the unethical manager can ignore the email and simply confirm verbally. Better is to phrase it as follows: “As per your verbal instructions to me today, I will be transferring $152,455 at time 12pm tomorrow unless I hear otherwise from you”. This is a little transparent but it makes the point. Create a scenario whereby the unethical manager has to respond to counter his verbal instruction.

The second documentation method, which combines with it witnesses, is by using meetings and meeting minutes. This requires that formal and informal committees be in place, best done before any decision-making is done and I will discuss in another section the structure of boards. What is important in meeting minutes is that if one person says that a comment was made then it is not a vote on whether it gets included. It gets included and if everybody else disagrees then the only thing that they can do to the minutes is include the statement that they all disagree. Too often boards and committees seem to believe that the contents of the minutes of a meeting are subject to a vote. They are not. Also, everyone present must sign the minutes. If they disagree with what is recorded, they voice it, it is included and then they sign. This is related to the regrettable tactic of people abstaining from votes, of which I shall also speak. This approach also has the benefit of other participants acting as witnesess.

Structuring formal boards and committees

A central pillar of corporate governance is to share authority. At the board level, directors have no individual authority unless the board assigns it to them. It is the board as a body that has authority. This authority is too often circumvented by the creation of an executive committee (exco) of the board. Although the existence of an exco does not mean that there will be corruption, when there is corruption it can usually be traced to the existence of an exco. The reason is that an exco effectively takes over the role of the board and the chairman of the exco becomes the de facto chairman of the board, replacing the elected chairman of the board. This is frightening.

This holds true at the executive level. The board must ensure that long-term strategic decisions are made by competent committees, not solely by the chief executive. A simple example is that you don’t want the chief executive to have sole authority over investments. That’s a one-man hedge fund. There is a balance between efficiency and governance, but that balance clearly isn’t an all-powerful chief executive.

I have seen different attempts at managing these issues. One unfortunate one that I’ve seen in this region is rejecting executives who want to be paid at the higher end of the market. The idea is that this way the executives hired are not greedy and will not commit fraud. This idea has several flaws.

The simplest flaw is that a dishonest executive is not going to care about his formal compensation as he will supplement it via fraud. A more subtle but far more dangerous flaw is the idea that the only alternative to someone who prioritises financial compensation is one whose incentive is to do a good job. In this region I have seen that the much greater percentage are those who prioritise power and those who prioritise publicity. Both of those incentives corrupt as much as, if not more than, financial incentives. I’m not sure people stuffing their friends into jobs or people using their positions to get on the front page are any better than people who think high performance should be rewarded with high pay.

Jawbone lessons

Jawbone, best known for fitness wearable technology, went into liquidation last month in part because of too much funding, according to CNBC. I believe that this is a good case study for some of the companies in the GCC that receive easy funding. Too often, certain investments are deemed strategic and then there is a blind mandate to fund them at any cost. One of the most frequent cases is the legacy business of a family conglomerate. Although other business lines might be doing fine and the commercially rational decision is to liquidate the legacy business, there is too much emotion tied to it. Often there is the belief that the loss of the legacy business would signal an unacceptable loss of face.

Of course if that funding is never-ending, you end up with zombie companies as the negative cash flows from operations and investing are offset by positive cash flows from funding, forever. This is why it is extremely important to look at the cash-flow statement. I have seen actual financial statements of large companies show that new debt funding is not only being used to pay for operations, an unsustainable situation, but to also pay off maturing debt. When you start using debt to pay for debt you’re in trouble.

The way this is explained to boards is that a certain debt is being matched to a certain activity. This is, of course, baloney – a proper analysis looks at the aggregate. If operating plus investment cash flows are negative and there is maturing debt it can only be paid off via more funding, be it equity or debt.

UNB kicks off earnings season

Abu Dhabi lender UNB announced its second-quarter financials. On the face of it things look positive with an increase in net profit of 7.2 per cent relative to the same period last year and that net income from interest and Islamic financing, the core business of a bank, rose 2.6 per cent. However, a quick peek at the underlying fundamentals shows that core revenue from interest and Islamic financing grew 6.4 per cent whilst expenses for interest and Islamic financing grew 13.4 per cent. Core expenses growing much faster than core revenue is unsustainable. When you factor in that operating expenses grew by a whopping 21.1 per cent the picture looks less than sterling. The main driver for the increase in net profit is retail fees and recoveries which grew 43.7 per cent.

Stay tuned as I take a deep dive into reported second-quarter earnings next week and uncover whether the net profit reported is quality or whether the underlying fundamentals are deteriorating.

Sabah al-Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com

Updated: July 13, 2017 07:31 PM