Tone at the top: there is nothing more important for the board to care about, and to assess.

• Author: Horton, Tom
• Position: Some Things Considered - Corporate culture and ethics

WHO KNOWS the origin of this phrase "tone at the top"? Used in recent years as the title of a newsletter of the Institute of Internal Auditors, it is not found in Bartlett's Familiar Quotations. It has, however, served to describe an important governance concept since at least 1987, when the National Commission on Fraudulent Financial Reporting used these words in issuing its recommendations. Five years later, its Committee of Sponsoring Organizations (COSO) published an integrated framework on effective internal controls, which again used the phrase, claiming this: "More than any other key individual, the chief executive sets the tone at the top that affects integrity and ethics and other factors of a positive control environment."

Whenever a chief executive's deeply felt values of honesty and fairness permeate an organization, its culture becomes an integral part of its control system, indeed its most effective part. In contrast, in a corporation headed by a person who cuts ethical corners there is no set of management controls and no audit committee strong enough to assure the integrity of financial reporting or of anything else.

COSO's landmark study, Fraudulent Financial Reporting: 1987-1997, showed that of 200 cases of alleged financial fraud that had been investigated by the Securities and Exchange Commission, the majority involved the overstatement of revenues, typically recorded prematurely and often even fictitiously, or of assets, including some that were nonexistent. These misstatements were not the result of low-level collusion. Instead, in five cases out of six, either the CEO, the CFO, or both were named as being complicit in the deceit.

In this particular study, most fraud in financial reporting among publicly held companies was found to be committed by small companies, many of whose boards were dominated by insiders who had little outside board experience. This is not to say, however, that investors in large companies are immune to fraud. Have we ever learned that fact of life in the last nine months! Just think Enron, Tyco, WorldCom and its telecom cohorts, ad nauseam. Not that long ago a prominent Broadway theatrical house was found to have kept two sets of books in what the SEC called "multifaceted and pervasive fraud," reminiscent of the Mel Brooks movie "The Producers," since reprised on Broadway, which celebrates the hilarity of a failed scam.

Such shenanigans are hardly limited to show business. As we now know, even...