Due diligence is a term most commonly used for the process whereby a potential purchaser evaluates a target company for acquisition. It amounts to an investigation of a potential investment that includes reviewing all financial records plus anything else deemed material to the sale. Offers to purchase are usually dependent on the results of due diligence analysis.

The importance of a due diligence – as many other business processes – is well illustrated by its failures. A high-profile example was the due diligence conducted for Hewlett-Packard on Autonomy, the UK software company. HP subsequently claimed that Autonomy had inflated the value of the company prior to the takeover, which led to a write-off of more than $8.8 billion related to allegedly fraudulent accounting at Autonomy.

While a breach of ethics is central to such accounting scandals, ethics has a further relevance for a due diligence.

A due diligence should serve to confirm all material facts and it is intended as a means to prevent unnecessary harm to either party involved in a transaction. But, in the absence of an ethical culture, the facts can be skewed by the company being sold - as illustrated by the example above. The acquisition can also pose significant future risks to the purchaser, ranging from liabilities and penalties associated with fraudulent practices to having to change the company’s entire culture. The difference between an ethical and unethical company is so noteworthy that ethics – or, specifically, a lack of ethics – should be considered a material fact.

Conducting an assessment of the organisation’s ethics as part of a due diligence can add considerably to the depth of insight into the target company. For an ethics assessment to add this value, there are four factors that need to be taken into account:

  1. An instrument should be used that will produce correct and trustworthy results. The effectiveness of a tool such as the Ethics Monitor survey is that it taps into employees’ knowledge as a way of surfacing and uncovering unethical behaviour. Although there are cases when knowledge of wrongdoing is limited to the perpetrator, in most cases there are other people within the business who know, or at least suspect, that something is not right.

  2. The results must have a high level of credibility. To realize this, the results should be based on the experiences and perceptions of all employees (including management and executive directors) and key stakeholders – or at least the vast majority. The views of the select few on the board of directors are too limited to being viewed as a credible, representative result.

  3. The assessment must produce meaningful results. As part of its contribution to a due diligence, an ethics assessment should quantify the organisation’s ethics to produce an ethics rating for the business. An ethics assessment should also provide in-depth insight into the ethics throughout the organisation – relative to leadership and across branches, departments and work levels - to identify areas of strength and vulnerability. This not only illustrates what can be done to remedy ethical weaknesses and to leverage ethical strengths, but also serves as an effective risk analysis.
  4. The ethics assessment should be conducted by an independent third party. This adds to the reliability of the assessment and avoids any suggestion of manipulated results. An independent third party can also offer the assurance of confidentiality and anonymity to allow respondents to share their views freely without fear of comeback.

  5. In order to evaluate the status of a company’s operational ethics, the following questions are also crucial:

    • How is the company’s Social and Ethics Committee viewed: as a compliance exercise or is it expected to add real value?

    • Does the company have an ethics strategy and clearly identified ethics goals? In the absence of this clarity, initiatives and actions to create an ethical workplace are likely to be fragmented and loose the benefits that an integrated approach can deliver.
    • Does the company report on its ethics? It should, as ethics reporting is a specific recommendation of King III and a requirement for the Companies Act Social and Ethics Committee. If it does, is the report supported by accurate, reliable measures of ethical performance and behaviour?

    • How does the company manage its ethics: proactively or reactively after there is a failure of ethics, regularly or on an ad-hoc basis?
    • Does the company provide ethics training to ensure it addresses ethical challenges and dilemmas effectively? Effective ethics training is one of the ways to establish a high level of ethical awareness, which contributes significantly to building and maintaining an ethical culture.

    • By Cynthia Schoeman

      Published in HR Future, May 2013