What can integrity due diligence reveal about management?
One in five of the managing directors and board members of Finnish publicly traded companies has a criminal conviction according to recent research. A positive correlation between a criminal record and inappropriate risk-taking has been observed that could possibly increase the risk of abuse in business operations. Hence, including inspection of the backgrounds, integrity due diligence (IDD), is justified in various internal processes ranging from executive elections to M&A discussions. The inspection not only provides information regarding the possible legal liability risks but also provides information about the risks regarding ethical and sustainable business operations’ continuity.
Companies should consider more detailed background checks when electing executives
The above-mentioned research conducted by the University of Oulu Business School, the University of Helsinki and the University of Eastern Finland provides the relevant perspective that companies should consider more detailed background checks when electing executives. From a total of 2,201 Finnish CEOs, members of the boards of directors and chairpersons of Finnish publicly traded companies, around 15.1% were women and 84.9% were men. Around 20% of the total sample of management personnel had been convicted of a criminal offence; the women’s share of the convicted managing directors and board members was 5.1% while the men’s was 94.9%. To guarantee uninterrupted business continuity, the identification of risks related to third-parties is required, as well as a process plan for how to effectively manage these risks.
A criminal record tends to imply a higher risk appetite and non-compliance
While discussing the research outcome, it should be made clear that the criminal records in the above-mentioned research paper cover a wide range of criminal actions with different degrees of severity, ranging from traffic offences (such as driving while intoxicated or endangering traffic safety) to crimes against life and health committed by executives. Based on the article discussion of the two research papers referenced in this article as well, persons with a criminal history have been shown to have a higher risk appetite than the rest of the population. Similar results have previously been identified within Swedish listed companies, where a criminal background has been shown to reduce compliance with the principle of prudence in accounting for instance.
According to Professor Juha-Pekka Kallunki, the leading author of two research papers referenced in this article on the matter, an ethical business culture and sustainable business values are difficult to implement if the company’s top management does not support them through their own behaviour. A criminal background can imply that a person is more willing to take risks which might hurt company-level decisions; for example, the person may be more willing to endorse worse acquisitions or take part in more aggressive tax planning.
Nevertheless, it should be noted that companies should consider the presented importance of background checks not only within the election process for the management team but also regarding its subsidiaries and other important business parties, and for instance, when looking into a potential acquisition target.
How to perceive the presented correlation?
IDD helps clients to protect the company’s most valuable assets and provides useful insights about the target individuals or companies that support more sophisticated decision-making. IDD can be performed for individuals as well as for companies, regardless of the form of business and the geography it operates in. However, to obtain more transparent information, it is often worth conducting IDD locally. Moreover, it should be noted that the legal admissibility of the background check must be assessed for each case separately.
A thorough IDD for a company can uncover serious red flag issues regarding, for instance, exposure to corruption, litigation and other reputational issues. IDD for an individual partly assesses similar matters, with a focus on, for example, known associates, company connections, sanction screening, media searches, and litigation and criminal case history (depending on availability). As with IDD for a company, the legal admissibility of the background check for an individual must be assessed in each case.
IDD can possibly raise significant red flags about the target company and its management that might otherwise be left unnoted. Other forms of due diligence than financial due diligence are often ignored though they could be considered to be a part of effective and responsible business operations and risk management that could provide an effective way to minimise the realisation of the risks associated with third parties. IDD comprises the gathering of independent information, from both public and non-public sources, in order to help understand the target’s track record, reputation, and integrity or corruption risks. With increasingly strict anti-corruption legislation in place around the world, pre-transaction IDD is a core element of transaction due diligence.