Tone at the Top: Defining Leadership & Ethical Corporate Culture

Tone at the top, commonly referred to in auditing, is used to define a company’s management and board of director’s leadershipLeadership TraitsLeadership traits refer to personal qualities that define effective leaders. Leadership refers to the ability of an individual or an organization to guide individuals, teams, or organizations toward the fulfillment of goals and objectives. Leadership plays an important function in management and their commitment to being honest and ethical. The tone at the top sets forth a company’s cultural environment and corporate values.

Summary:

• Tone at the top is used to define the management and the board of director’s leadership and commitment to being honest and ethical.
• Tone at the top was popularized due to numerous corporate accounting scandals such as Enron, WorldCom, Adelphia, etc.
• Tone at the top carries a significant impact on a company’s cultural environment and corporate values.

History of Tone at the Top

The phrase, “tone at the top”, originated from auditing firms, where it was used to reference the attitude of a company’s management towards internal controls and ethics. Following a number of corporate accounting scandals, such as Enron, WorldCom, Adelphia, etc., the Sarbanes-Oxley (SOX) Act of 2002FP&AFinancial Planning and Analysis (FP&A) is an important function at a corporation. FP&A professionals support executive decision making for popularized the term “tone at the top” – an element that was missing in the preceding scandals mentioned.

Understanding Tone at the Top

The tone at the top outlines that the board of directorsBoard of DirectorsA board of directors is a panel of people elected to represent shareholders. Every public company is required to install a board of directors. and management team should embody and not merely pay “lip service” to compliance and upholding ethics. It states that those at the top of the organization should be honest, show integrity, and uphold an ethically-correct corporate culture.

The tone at the top, as the name implies, starts at the top and trickles down into middle-management and eventually to the bottom line.  A company with a poor tone results in a company that is more likely to display unethical behavior, engage in fraudulent activity, and not support internal controls.

For example, consider a management team that disregards internal controls. This can appear in the form of over-recording assets on the balance sheetBalance SheetThe balance sheet is one of the three fundamental financial statements. The financial statements are key to both financial modeling and accounting., not reconciling the general ledger, or not complying with company policies. Employees, seeing that the management is not abiding by policies or internal controls, will likely tend to mimic their behaviors. This results in an organization that is more prone to engaging in fraudulent activities. Therefore, the tone at the top sets forth the company’s culture and values.

Methods to Improve the Tone

There are several ways to improve a company’s tone at the top:

1. Communicating, promoting, and displaying ethics and values

Management and the board of directors should clearly communicate and promote ethics and values, e.g., have a written code of conduct, hold frequent staff meetings, and engage in informal conversations that communicate and promote the company’s ethics and values. In addition, management and the board of directors should display their commitment to abiding by the ethics and rules set.

2. Encouragement to report misconduct

Employees should be able to safely report misconduct that occurs at the company. “Safely” is in reference to being able to report misconduct without the fear of facing repercussions from others – For example, having a corporate reporting hotline that guarantees anonymity. Providing a safe outlet for employees to report misconduct or unethical behavior helps to regulate any undesirable behavior that may occur.

3. Rewarding integrity

Management and the board of directors should reward individuals who show integrity and uphold the values set by the company. Employees are thus able to recognize that they are being acknowledged by those around them for the good behavior that they display.

Example

The following example outlines how a poor tone at the top trickles down to other members of an organization:

John is the senior manager in Billing Collections at ABC Company. Over the past years, to meet analyst expectations, he’s been pressured by upper-level management to constantly help the company achieve revenue growth. One day, John overhears the upper-level management outlining a scheme to record revenue earlier than permitted and to think of ways to manipulate the company’s financial records.

As John overhears the conversation, he begins to devise ideas himself on how to manipulate the company’s records. He does not believe that he is doing anything wrong, as his supervisors are actively engaging in the same behavior. To such an end, he decides to manipulate financial statements by hiding uncollectible debtBad Debt Expense Journal EntryFirst, let’s determine what the term bad debt means. Sometimes, at the end of the fiscal period, when a company goes to prepare its financial statements, it needs to determine what portion of its receivables is collectible. The portion that a company believes is uncollectible is what is called “bad debt expense.” The, aggressively recording sales when not permitted to, and hiding outstanding debt payments.

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Accounting EthicsAccounting EthicsAccounting ethics is an important topic because, as accountants, we are the key personnel who access the financial information of individuals
• Mission & ValuesMission & ValuesCFI's mission is to help anyone become a world-class financial analyst. Learn more about Corporate Finance Institute's mission, vision, values and culture
• Top Accounting ScandalsTop Accounting ScandalsThe last two decades saw some of the worst accounting scandals in history. Billions of dollars were lost as a result of these financial disasters. In this
• Whistleblower PolicyWhistleblower PolicyA whistleblower policy is now considered a very critical part of almost all organizations, as a result of legal issues. Whistleblowers almost always become