During a recent conversation I had with a fellow public company director, the subject of board detection of corporate wrongdoing came up. She told me that her approach was always to meet privately with the internal and external auditors to explain that they could always speak with her in confidence if they had an issue not appropriately addressed by management. Her words made me smile; they reminded me of a conversation I had over 25 years ago with similar parties at Sunbeam, where I was serving on my first public corporate board. There, I went so far as to give the auditors my home phone number (pre-cell phone, of course) and told each of them that they could call me any time of the day or night with a concern.

At the time, it seemed like a good practice. If they viewed me as a conscientious, independent director, they would have no fear coming forward with important information that could save the business from financial disaster.

Regrettably, though, no one there contacted me in any way, shape or form prior to the managerial and accounting disaster that would later devastate the company and lead to the termination of its CEO in a particularly public implosion.
 

The reason, as I later surmised, was rather simple. First, employees view a board as aligned with management and not particularly sympathetic to employee concerns. Second, to come forward means the significant potential of losing one’s job and primary source of income — a risk few would take. You can tell someone that you are independent and motivated to correct wrongdoing, but how do they know that you will follow through with it? Is it worth the risk to them of potential personal devastation?

There is no easy solution to this problem. Even the now-ubiquitous fraud “hotlines” do not provide the answer. Thirty years of board research and service, though, have helped me develop a few relevant thoughts on a more productive approach.

I have always believed that broad-based equity ownership by employees is a very positive thing for an organization. It links the employee’s wealth and future to the success of the business itself and not a particular mismanaging CEO or supervisor. But alone, it is not the answer to the misconduct problem. It merely provides some incentive to come forward.

This is why director independence is so important. The less connected a director appears to be to management — and the more of a management monitor the director seems to be — the greater likelihood of someone deciding to come forward. Additionally, it is always a good idea to establish a positive relationship with the internal and external auditors, more than simply attending formal meetings. It is easier to discuss a problem with a professional friend than someone whom you merely view as a distant supervisor.

But encouraging effective reporting is much broader. It is cultural and begins with the CEO. A leader with real personal integrity and transparency sets the tone for the entire organization. Companies (and nonprofits) led by such individuals are a pleasure to work for. They typically attract the best and brightest. Corporate cultures in which transparency is a core value make it easier for employees to report up when there is an integrity issue. They are also less likely to develop such problems to begin with.

Since the board is responsible for finding the best CEO, among the top qualities it should look for are integrity and transparency. Of course, these are not traits that are easily and publicly quantifiable. That is where judgment enters the equation. Reliable judgment is why good directors are so valued.

Although the notion of an appropriate “tone at the top” sometimes seems a bit cliché, my experience suggests otherwise. It is a critical element in creating a vibrant and sustainable business. Combined with equity-holding, independent directors and broad-based share ownership by employees, it is our best hope for creating and maintaining the kind of successful enterprise investors demand and deserve.
 
Charles Elson is executive editor-at-large for Directors & Boards.