On Thursday, July 19, 2007, Northrop Grumman Chairman and Chief Executive Officer Ronald Sugar delivered a speech to the Leadership Excellence Summit 2007 at Alumni Hall, United States Naval Academy, Annapolis, Maryland. Below are his delivered remarks.

Ethics: The Precondition for Business Success

Good morning. I am very pleased to be here. I never get tired of coming to this campus. There is history in every brick – and inspiration, too. These halls have produced some of the most selfless and courageous Americans in our history. It would be hard to find a better place to discuss ethics than right here.

As I said, this is not my first visit to this campus. Nor is it my first time here to discuss ethics.

I spoke at a special conference here in 2003, along with Senator Paul Sarbanes, other CEOs, and respected ethicists.

As you know, the bill he co-authored – Sarbanes-Oxley – redefined the standards for compliance across American business. It was a forceful legislative reaction to high profile events.

Sarbanes-Oxley turned out to be a hard swing of the pendulum in response to growing fear that our free-market system was in danger of collapse – over real and imagined breakdowns in corporate ethics. It was a painful process, as well as expensive.

Its pain was aggravated by the fact that the vast majority of American companies were honest and their accounting practices were sound and ethical.

But in retrospect, Sarbanes-Oxley was needed if for no other reason than to ensure that everyone played by the same rules. Five years later, I think it has proven worthwhile, though it could now certainly benefit from some judicious streamlining and process improvements.

But at the end of the day, laws like Sarbanes-Oxley are reactionary. They are created after the damage is done – after innocent stock holders have been burned; after employees have lost their retirements; after the public has lost faith in whole industries and in the companies that comprise them. There has to be a better way – a more forward-leaning, preventive way – for companies to operate. There has to be a way for companies to foster cultures which anticipate and correct problems before they become uncontrollable or destructive. Well, I think there is, and that is what I would like to talk to you about this morning.

The first step in establishing this better way is to recognize just how essential good ethics are to good business. Speaking on this topic years ago, the President said, quote, “All investment is an act of faith. And faith is earned by integrity. In the long run,” he went on, “there is no capitalism without conscience, and there is no wealth without character,” unquote.

The cynic might assert that a strong ethical code serves the businessman only as a public relations strategy.

Wrong.

Ethics are the very underpinnings of business. As such, they are the foundation of our free-enterprise system – the system that has made us the most prosperous, healthy, educated people in human history.

But it is a competitive system. And no business or individual who seeks its fruits can survive without offering customers or investors a reasonable expectation of honest dealings. When Warren Buffet said that it takes twenty years to build a reputation and five minutes to ruin it, he was doing more than turning a good phrase. He was expressing just how critical public perception is to any business.

This law of business is magnified ten-fold in the industry in which my company operates – national security. Northrop Grumman has a powerful vision statement. “Our vision is to be the most trusted provider of systems and technologies that ensure the security and freedom of our nation and its allies.” Not the biggest provider; not the most profitable provider; not the fastest growing provider – rather, the most trusted provider. These words were chosen very carefully.

And the reason is because no industry is more dependent on its code of ethics than the defense industry – in three very important ways.

First, the stakes of what we do are much higher than those of many non-defense industries. The products we build are critical to our defense and our very survival. Standards and practices that might be fine for non-defe nse industries are often inadequate for ours.

The Second World War was the last war our nation fought without a dedicated defense industry. As happened in all wars previous to that, the civilian industry was temporarily bent to the task of manufacturing military products. But what might have worked during the First World War did not work during the second. Defense technology had grown too complex, aircraft in particular.

Ford Motor Company built the enormous Willow Run plant south of Detroit to build B-24 bombers. But they made the initial mistake of simply transferring auto manufacturing mass production techniques and standards to warplane construction. The results were dismal for the first aircraft made there, and tragic for some of the air crews who flew them. America’s early battle tank production had similar problems for similar reasons. From that point forward, defense production ceased to be interchangeable with civilian industry.

During his 1961 farewell address to the nation, President Eisenhower recognized this. He observed that, “Until the latest of our world conflicts, the United States had no armaments industry. American makers of plowshares could, with time and as required, make swords as well. But now we can no longer risk emergency improvisation of national defense." He then went on to characterize the development of a permanent defense industry as, “imperative”.

Eisenhower understood that our defense industry requires a higher standard of manufacturing, management, leadership, and yes, ethics. In our line of work, these standards can mean life or death. The young men and women who put on the uniform every day and go into harm’s way on our behalf expect and deserve our very best efforts.

Which brings me to the second way in which our industry is unique – the ethical standards of those we equip and support. Think of the crew of the small destroyer escort, USS Johnston, during the battle of Leyte Gulf, sacrificing themselves against a column of Japanese cruisers and battleships; Think of all the American pilots over North Vietnam – Air Force pilots out of Thailand and Navy pilots from Yankee Station – and how they routinely made dummy passes at anti-aircraft batteries to draw fire away from other aircraft on their runs. Think of Somalia when Army Rangers, trying to get their wounded back to base, just barely made it through a murderous gauntlet of fire. They dropped off their wounded then turned right around and headed back out into the gunfire to rescue those left behind. And think of Marine Corporal Jason Dunham, awarded the Medal of Honor earlier this year for saving the lives of his buddies in Baghdad by smothering a grenade with his body. What they all had in common was this: They were all more afraid of letting down their comrades than of death itself. You can’t write a selflessness clause like that into any employment contract.

For Americans like them, notions of honor, duty, and responsibility are neither quaint nor theoretical. They are, instead, matters of life and death. America’s war fighters are idealists, and those idealists are my industry’s customers. We cannot retain their confidence in us unless our diligence approaches theirs.

This brings me to the third way our industry is dependent on ethics – our partnership with the United States government. To a much larger degree than any other industry, the corporate futures of America’s defense companies brighten or darken in proportion to the faith placed in us by our government.

Most Americans are surprised to learn that our industry is not the economic juggernaut they perceive it to be.

By just about any measure – profit margin, market capitalization, total revenue, number of employees – we are smaller than the energy, retail, pharmaceuticals, internet software, even entertainment industry. The market value of Microsoft Corporation alone exceeds that of Northrop, Lockheed, Boeing, Raytheon and General Dynamics – combined.

And our customer base is narrowly focused by comparison. But because of who that customer is, our industry has a very low tolerance for scandal. If the taxpayers turn their backs on us, their elected representatives will too. And our stockholders will soon follow.

It would be difficult to overstate the importance of ethics to business in general and the defense industry in particular. But how best to translate the ethical imperative into action?

Well, for starters, the importance of ethical practices needs to be reflected in a company’s leadership structure. This starts with the tone at the top: The Board of Directors, the CEO and the senior leadership team. It must be viewed as a core value, not merely a compliance obligation.

But there must also be strong processes as well. There must be institutional mechanisms for training and compliance. Like many companies, at Northrop Grumman we created an office of Corporate Responsibility. And we elevated the leadership of that office to Vice President, directly accountable to the executive office, and with regular and direct access to our Board of Directors.

This function ensures that lines of communications are open and go both ways. Many companies maintain hot lines, help lines and tip lines. We call ours the OpenLine to emphasize that it is open to anyone with a question, a comment, a concern or a piece of information. We want our employees to call. Every major operation of our company has a designated Business Conduct Officer.

We strive for an environment of trust where employees feel comfortable raising issues or concerns to their supervisors, to their management, to the ethics office or even to me. I get many interesting e-mails during the course of a year, and I treat every one as an important OpenLine message.

At Northrop Grumman, we regularly communicate the importance of ethics to everyone from the members of our Board of Directors to all our employees. And we keep doing so throughout everyone’s career. Each of our 320 vice presidents participates in a four hour course on ethics as a part of their week-long leadership training program.

And every year I make integrity one of my annual corporate priorities, ensuring that every Northrop Grumman employee understands that integrity is not optional; it is everyone’s job. I always say that we are only as strong as our weakest link.

Training and compliance are not enough. The creation of an ethical culture requires leadership – a culture that encourages open discussion and the reporting of ethical, legal, procedural, and policy violations.

Our Board receives quarterly and annual ethics reports and conducts its own reviews, looking down into the organization. And we regularly share with government customers our ethics initiatives, concerns and progress.

Since you cannot manage what you cannot measure, we collect metric data. For example, Northrop Grumman participates in the DII business ethics survey in order to evaluate our ethical culture and focus our future efforts.

What is DII? It stands for Defense Industry Initiative, and it represents another important way that corporate ethics can be promoted and advanced – by self-policing industry-wide. Let me say a few words about it.

DII has become a strong moral compass for America’s defense industry – a compass our industry did not have twenty years ago. It was conceived within a maelstrom of scandals, allegations and improprieties that spawned the Packard Commission study. In 1986, that commission reported that the American public had a lack of confidence in our industry. It concluded that defense companies could benefit from a greater emphasis on corporate self-governance. Soon thereafter, the CEOs of that time got together to draft the principles that would become the Defense Industry Initiative.

Far from window dressing, the DII has real ballast to it. Each DII signatory pledges to uphold six fundamental principles:

  • They must adhere to written codes of conduct;
  • They must train employees in those codes;
  • They must encourage the internal reporting of code violations;
  • They must practice self-governance;
  • They must share “best practices” with other firms.
  • And they must be accountable to the public.

The next step is to extend the progress of the DII internationally. So, I and my fellow defense CEO’s are actively advancing an international counterpart to the DII with our international industry partners and our key allies in Europe, the UK, Japan and elsewhere. Doing so is not only right; it is in our industry’s best interests. Establishing a common standard of ethics will help level the competitive playing field for all and it will help improve progress toward export control reform.

Well, half a decade after Sarbanes-Oxley became law, I think most American business leaders would agree that the law was necessary, but not optimal. It is far preferable to impose a code of ethical behavior on yourself than to have one imposed on you from outside. And it would certainly be easier if ethical behavior were separate from organizational success. But it isn’t. Luckily, it is within the power of every business organization to harness the great power of ethical behavior to its benefit, and the benefit of customers and investors as well.