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The OCR Glossary

Codes of Conduct

S. Prakash Sethi

Voluntary codes of conduct were created at the initiative of individual corporations, single and multi-industry groups, and regional and global organizations in response to globalization and the gap between existing regulatory regimes and the scope of corporate conduct that regulations are intended to cover that arises from the growth in the number of multinational corporations.

From the perspective of public policy and corporate strategy, voluntary codes of conduct allow companies to create a proactive stance as to how they plan to address issues pertaining to environment and sustainability, social aspects of human resource utilization, and governance—specifically the transparency and accountability of corporate actions. The primary focus of these codes of conduct is to (a) address public concerns and build further trust in corporate assertions and (b) take actions that would ameliorate these concerns without unduly restricting corporate managers in the conduct of their business or imposing onerous regulatory oversight and heavy financial burdens.

This entry covers the intellectual foundations underlying voluntary codes of conduct, the private law character of voluntary codes of conduct, three types of voluntary codes of conduct, and the deep void between the rhetoric and the reality of voluntary codes of conduct.

Intellectual Foundations Underlying Voluntary Codes of Conduct

A voluntary code of conduct consists of a set of activities that the sponsoring organization (SO) commits to undertake. The effectiveness of an SO’s responses to society’s concerns depends on a number of factors: (a) the sociopolitical environment, (b) public awareness, (c) the emotional intensity generated by the issue, (d) the dynamics of competition and the industry structure in which the company operates, and (e) the institutional character, corporate resources, and management style of a particular corporation.

The business case or economic justification for corporate social responsibility (CSR) principles or codes of conduct is infinitely more complex than that for conventional business principles or codes. In direct contrast to conventional principles or codes, CSR-related codes of conduct call for companies and industry groups to voluntarily assume some of the costs associated with the industry’s negative externalities. Consequently, voluntary codes of conduct in the sociopolitical arena have a different rationale that includes both economic and noneconomic considerations, and they raise difficult issues toward implementation.

To be effective, such codes must have a large measure of acceptability from all relevant stakeholders and must fit in with the competitive realities of the marketplace. They must be dynamic and flexible to respond to evolving conditions. A specific action can be socially responsible only if it takes account of the time, environment, and interests of the parties involved. The same activity may be considered socially responsible at one time, under one set of circumstances, and in one culture, but it may be considered socially irresponsible when any of these factors change.

Private Law Character of Voluntary Codes of Conduct

Unlike externally imposed regulations and compliance requirements, a voluntary code of conduct is in the nature of a “private law” or a “promise voluntarily made,” whereby an institution makes a public commitment to certain standards of conduct. The nature of voluntariness and, by implication, the flexibility afforded to companies depends on the premise that the SOs and their critics share a common interest in improving the underlying conditions of the affected groups and regions and a common understanding that it is in the interest of all parties to resolve the underlying issues within the realistic constraints of the available financial resources and competitive conditions.

The private law character of voluntary codes of conduct gives the SO a large measure of discretionary space for action. However, it also imposes a heavy burden on the organization to create independent systems of performance evaluation, monitoring and verification, and public disclosure. This is a proactive stance and perhaps the best of all possible worlds. The success of this system, however, depends on the SO’s ability to create and sustain a high level of public credibility. The private law character of the code does not reduce the obligations of the companies or industry groups; it increases their burden to ensure that skeptical critics and the public at large believe in the industry’s response and performance claims.

From the public’s perspective, voluntary codes also serve an important purpose. They avoid the need for further governmental regulation, with the prospect of imposition of onerous regulatory conditions. They also allow the moderate elements among the affected groups to seek reasonable solutions to the issues involved.

Analytical Framework for Examining Voluntary Codes

There are two sets of considerations that influence a particular code’s saliency and effectiveness:

  1. The first is the specific contextual elements of a code as to what it expects from its adherents by way of implementation, compliance, performance, and transparency in reporting to the code’s important stakeholders and the community at large. The narrative of a code’s contextual elements and its implementation standards would affect the level of expectations and trust on the part of external stakeholders as to the quality of reporting by the code’s sponsors.
  2. The second set comprises the internal factors—that is, the incentives and disincentives available to individual companies or industry groups—that would induce or discourage their compliance with a particular code.

This framework has been developed through an analysis of voluntary codes of conduct promulgated by individual companies, industry groups, and multisector and global organizations (see Figure 1). It is important to note here that the purpose of this exercise is not to create distinctions between strong and weak codes but to suggest structural attributes of various types of voluntary codes and the type of approach necessary to ensure the viability and credibility of these codes both for the SOs and for their external constituencies.

Figure 1 Confluence of Member Characteristics and Motivations and the Scope of Principles and Implementation Structures in Creating Effective Voluntary Codes of Conduct

The first dimension is defined by the number of participating entities, the cohesiveness of their purpose, their view of the sociopolitical environment, and their willingness to share the costs and benefits of implementing a particular code of conduct. It suggests that the level of cohesiveness invariably suffers with every increase in the number of participants and the divergence in their views as to the scope of voluntary principles, the method of implementation and monitoring, and discipline activities.

The second dimension consists of the nature and scope of the principles or specific undertakings that are incorporated in the voluntary principles or code of conduct. As membership becomes more heterogeneous (either in business or in the region of operation), application specificity decreases and principles become more aspirational than compliance oriented. The two issues of adverse selection and free riders can be explained using these dimensions. The primary driver of adverse selection is the number of participating entities.

As the number of participants increases, it makes it difficult to maintain both group cohesiveness and code specificity since a code must accommodate the members’ increasingly divergent interests. This within-group variability makes it tempting for an increasing number of free riders to become code members. The number of free riders (those unwilling to share the costs but who gladly reap the benefits) also increases with a decline in the group’s cohesiveness and the consequent loss of efficient governance. This situation also appeals to companies with the worst track record, who would be quite interested in joining the group at the first opportunity to enhance their otherwise poor reputation by publicizing their group membership—that is, adverse selection. Unfortunately, adverse selection—when pronounced—could be quite detrimental to the survival and success of the group, since it would discourage high-performing companies from joining the code group for fear of sullying their reputation.

Three Types of Voluntary Codes of Conduct

Voluntary codes dealing with environmental, social, and governance issues can be grouped into three categories: (1) individual or company-based codes of conduct, (2) industry-based codes of conduct, and, (3) universal—that is, multisector or multicountry—codes of conduct. Each of these codes has their unique characteristics and also poses different challenges for SOs.

A company-based code of conduct is the most likely initial corporate response to social pressures, especially when the issues involved emanate directly from the company’s core business operations. A company-based code provides its sponsor considerable flexibility in defining the parameters of the social issue in contention—especially in its earlier stages of public awareness. It also allows the company to offer solutions that build on its strengths. There are also no problems of free riders and adverse selection. Therefore, a meaningful company-sponsored code, when thoughtfully implemented and providing measurable results, can return enormous dividends in terms of the first mover’s advantage, enhancement in corporate reputation, and public trust.

Industry-based voluntary codes of conduct dealing with societal issues serve an important business and social purpose. They provide industry members with a mechanism to develop solutions that are focused, take cognizance of the industry’s special needs and public concerns, and are economically efficient. They engender public trust through the “reputation effect” while avoiding being tainted by the actions of other companies.

Voluntary business groupings, however, must contend with two problems, free riders and adverse selection, the magnitude and severity of which could adversely affect their collective operation. The free-rider problem accrues from the situation where some type of pressure or coercion is necessary to ensure that member organizations, which benefit from the collective effort, also share the cost of maintaining such effort in proportion to the benefits derived from them. Adverse selection occurs where companies joining the group are likely to exploit the benefits accruing from their participation in the group without any consideration of the harm that their actions might cause other members of the group.

Universal codes of corporate conduct confront the same set of problems as industry-wide codes of conduct. However, in this instance, universal codes have fewer advantages of common ground, which prevail in the case of industry-wide codes of conduct. For universal codes, the issues of free riders and adverse selection are further amplified since in their desire to entice and encompass the largest number of corporate participants, code sponsors invariably yield ground in terms of meaningful adherence to the code’s principles. Unfortunately, this relaxation or weakening of compliance standards—when accompanied by a relative lack of transparency—diminishes the reputational value of group membership and takes away what little incentive there remains to comply beyond empty rhetoric.

Voluntary Codes: Bridging the Void Between Rhetoric and Reality

From one perspective, it would seem that individual corporations, industry groups, and multisector, multi-industry groups have enthusiastically embraced the institution of voluntary codes. For example, in a recent study of CSR reports of the 614 largest corporations from around the world, it was noted that with few exceptions (18 out of 614) they had collectively signed 1,571 codes of conduct. And yet not a single company reported any information about its activities toward implementing these codes and the specifics of its compliance in the 2014 edition of the CSR Sustainability Monitor.

Available evidence, however, shows that companies, in general, have been reluctant to provide sufficient information in their external communications with regard to environmental, social, and governance issues as envisaged in their codes of conduct. This is unfortunate because it may lead to further deterioration of corporate reputation among important stakeholders and the public at large. Equally important, it would also diminish the potency of CSR reports as potentially the most important discretionary communication medium for which there is no easy substitution.

The future relevance of voluntary codes of conduct must rest solely on corporations, the principal sponsoring institutions, which are also their primary beneficiaries. For this to happen, it is important that corporations pay attention to the preconditions identified by S. Prakash Sethi in his 2011 book Globalization and Self-Regulation: The Crucial Role That Corporate Codes of Conduct Play in Global Business. These preconditions are as follows:

  1. Substance: The code must substantively address broad areas of public concern pertaining to the industry’s conduct.
  2. Specificity: The code must be specific in addressing issues embodied in those principles.
  3. Realism: The code must be realistic in the context of the industry’s financial strength and competitive environment without exaggerated promises or claiming implausible achievements.
  4. Compliance assurance: The companies must create an effective internal implementation system to ensure that their code compliance is effective.
  5. Integrated into evaluation and reward systems: The companies must make compliance an integral part of their management performance evaluation and reward system.
  6. Independent governance structure: The industry must create an independent governance structure that is not controlled by the executives of the member companies.
  7. Verification system: The industry must have an independent external monitoring and compliance verification system to engender public trust and credibility in the industry’s claims of performance.
  8. Transparency and disclosure: There should be maximum transparency and verifiable disclosure of the industry’s performance to the public. Standards of performance disclosure should be the sole province of the code’s governing board.

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See Also

Accountability; Corporate Political Activity; Corporate Social Performance; Corporate Social Responsibility; Corporate Social Responsibility, Communication of; Environmental Performance; Ethics of Reputation Management; Information Intermediaries; Organizational Trust; Reputation Monitoring; Reputational Commons; Reputational Spillovers; Stakeholders; Transparency; Workplace Performance

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