Conflict of Interest: Looking to Other Industry ModelsJuly 15, 2010

 

Last week, the Wharton Aerospace and Defense Report addressed how Lockheed Martin is reshaping the company by divesting from two units in a move to avoid conflict of interest.
{LINK http://executiveeducation.wharton.upenn.edu/wharton-aerospace-defense-report/
Lockheed-Martin-Adapts-to-Meet-New-Rules-0710.cfm} The decision was driven by new rules the Pentagon recently drafted to minimize potential conflicts of interest for its contractors.

Aerospace and defense companies are keenly sensitive to the new acquisition rules because they are especially dependent on Pentagon contracts. The way companies manage conflict of interest in other industries without divesting units could serve as a model for the defense industry.

Take, for example, the advertising industry, where holding company structures have become common, precisely to address conflict of interest concerns. "If an advertising agency serves a client such as P&G, that agency will generally not take on work for Unilever or other direct competitors," says Kevin Werbach, {http://www.wharton.upenn.edu/faculty/werbach.cfm} a professor of legal studies and business ethics at Wharton. "The holding company structure allows conflicting clients to be served through different agencies under the same holding company, such as WPP or Interpublic." The structure maintains enough separation between the individual agencies so that divestiture isn't required.

The other situation is in the merger context, especially in regulated industries. It is not uncommon for large companies that merge to divest assets, either preemptively or in response to antitrust review. However, that's typically to promote competition, rather than to remove a conflict of interest, says Werbach.

Finally, one of the causes of the financial abuses several years ago was the potential conflict when auditing firms also sought consulting work from the firms they audited. The Sarbanes-Oxley legislation largely outlawed this practice, requiring restructuring of some of the Big Four accounting firms. Similar ideas have been proposed for ratings agencies in the wake of the recent financial crisis, although that's not entirely analogous, says Werbach.