The Treatment of Employees in High-tech Start-ups

A Test of Executive Character

Dennis J. Moberg

Weakness rather than evil accounts for many instances of unethical behavior.

Going to work for a high-tech start-up involves big career risks. Pay is low, hours are long and life in a start-up requires family sacrifices. Sometimes the risks pay off, and employees earn wealth beyond their wildest dreams. More often, things do not turn out, and employees end up with little to show for their sweat equity. A 1997 study by the National Federation of Independent Business's Education Foundation estimates that over the lifetime of businesses, 39 percent are profitable, 30 percent break even and 30 percent lose money (with 1 percent falling into the "unable to determine" category).

Employees who fare poorly are understandably tempted to engage in blame, and the objects of their derision are typically the people who head their firms. After all, the executives seem to come out ahead no matter how poorly employees do. Thus, feeling bad easily becomes feeling screwed.

Yet, I have found that high-tech start-ups are difficult places to prove employee allegations of unethical treatment. Cases I have investigated seldom boil down to clear violations of ethical principles. Objective fact-finding is difficult. The people involved often see the same situation differently, and too often the issue boils down to "he says-she says."

Take the case of an employee who contends that he was promised a bonus for completing an engineering design only to find that, with high turnover typical of start-ups, the person who made the promise has left the organization. The person’s replacement contends that the design no longer meets business needs, and besides it does not meet engineering standards.

In this case, was a promise violated? Was the design acceptable? Were the engineering standards reasonable? Who is the victim, and who is the perpetrator? There may be third parties who want to weigh in on this kind of case, but as an ethicist, I have learned to be humble about questioning other people’s ethics.

Moreover, since start-ups involve people doing things for the first time, when bad treatment of employees does occur, it is often unintentional, the result of inexperience rather than malice. In short, it is tough to pinpoint moral responsibility in the start-up context.

The traditional focus of business ethics is the morality of action. This results in conclusions about which business practices are acceptable and which are wrong. For example, employees have ethical rights. When a business practice violates these rights, this practice is unethical, period.

But in the start-up, as we have seen, this traditional approach does not always work well. An alternative focus is the morality of character—what human traits are associated with virtue and goodness on the one hand and vice and evil on the other. Using this alternative approach, two key points can be made about the ethical treatment of employees. First, most start-ups are inhospitable places for genuine scoundrels. Second, while start-up executives generally try to treat their employees ethically, there are four temptations that keep them from being at their best.

No Place for Really Bad People

Ethicists have spent more time studying virtue than vice. However, my research on bad, vice-ridden people shows that they are not drawn to settings like the typical start-up company.

Really bad people are lured to situations that promise immediate gratification such as confidence games, investment scams and phony telemarketing schemes. These are commercial enterprises with very low costs of entry, which can be exited quickly and anonymously.

Most start-ups require far too much deferred satisfaction to be a haven for villains. To be involved in high-tech, one typically must have spent many years in technical or professional education and, in addition, inspire the trust of smart colleagues and business partners.

One exception seems to have been the flimsier dot-coms that appeared during the recent Internet start-up frenzy. These attracted an unusual number of scoundrels, according to an article in the Financial Times. Author Caroline Daniel reported on research by Kroll Associates, a corporate security company that conducts due diligence background investigations of executives and board members.

Typically, the company finds problems in about 10 percent of the cases they investigate. But in 2000, a check of 70 Internet executives turned up problems in 39 percent of the cases. Kroll attributed the rise, in part, to the pace of Internet investing and, in part, to the fact that many dot-coms had not adopted "traditional forms of corporate governance, such as holding regular board meetings to monitor decisions and the flow of money."

The Fundamental Elements of Executive Character

This is a troubling discovery, and it points to the need to abide by the established checks and balances of corporate governance, even in the high-speed world of eBusiness. But the firm’s baseline finding—that 90 percent of its investigations reveal no problems—suggests that the vast majority of CEOs are not outright evil.

When employees are abused in high-tech start-ups, the root cause is more likely to be weakness. Entrepreneurs, like everyone else, are subject to all the enticements that tempt good people to cheat, cut corners and fall prey to greed.

The best defense against weakness is character development. Both Aristotle and St. Thomas Aquinas identified four fundamental traits of character known as the cardinal virtues. These are justice, temperance, courage and wisdom. If fully developed in executives, these virtues guide them to make not just ethical but morally superior decisions. That means that virtuous executives will advance employee interests if at all humanly possible.

In high-tech start-ups, executives must successfully meet several predictable tests of character I call "temptations." These stumbling blocks keep executives from being their best. Interestingly, each temptation threatens the expression of a different cardinal virtue.

Temptation #1 — Tree-ring Distinctions

The many decisions governing the distribution of rewards in a high-tech start-up are genuine tests of character. Characteristically, close attention is paid to when employees enter the organization. This is done to determine their ownership stake once the firm goes public. Founders have the largest claims, followed by the employees hired early in the company’s life. Later employees have smaller claims, and some enter too late to cash in on the IPO bonanza.

This practice of making tree-ring distinctions is fraught with moral hazards. Executives can be tempted to distribute financial rewards that favor their friends and family and exclude those more deserving. They can also be tempted to ignore fair procedures at arriving at these distributions.

The cardinal virtue most implicated by this stumbling block is justice. As a highly desirable moral trait, the virtue of justice immunizes an executive against the temptations associated with tree-ring distinctions. Those executives who have cultivated the habit of making choices that advance justice will find ways to support the legitimate demands of employees for fair treatment.

Temptation #2 — Candor Calibrations

The heart of any high-tech start-up is enthusiasm, and its lifeblood is information. This combination creates difficult choices for any executive. For the start-up firm to be successful, accurate information must flow freely from bottom to top, from marketplace to laboratory, and from one department to another. At the same time, leadership requires that information be expressed in an optimistic, hopeful way. If executives describe the glass as half empty rather than half full, employees will lose the motivation the start-up needs to sustain itself.

To understand the challenges associated with the intersection of information and enthusiasm, it is necessary to distinguish between honesty and candor. Honest messages communicate truthfully. Candid messages communicate truthfully and completely. In this sense, it is not honesty that is at stake at the intersection of information and enthusiasm. Rather, it is candor that must be calibrated. For example, what should a prospective new employee be told about the prospects of a company during a recruiting encounter? Similarly, should an existing employee be told of a possible negative development with the firm’s supplier of venture capital?

The cardinal virtue of temperance enables executives to find answers to these questions. Also known as moderation, temperance guides virtuous people to avoid the extremes of human interaction. The troublesome extremes in a high-tech firm lie on two spectrums, one having to do with how much information is shared and the other with the light in which the information is cast.

In the first instance, one finds the extremes of drastically restricting information on a strict need-to-know basis vs. revealing so much that the company is put at risk. When moderate, an executive would be open enough to keep employees connected. The extremes in the second spectrum might be exaggeration on the one hand and negativity on the other. The moderate executive on this spectrum would engage in optimistic, motivating communication without too much hype.

Executives with the virtue of temperance find ways to calibrate candor by avoiding the extremes. Employee trust generally follows from this practice. Warren Anderson says he "generally erred on the side of more rather than less information" as founder and CEO of Anderson Soft-Teach, a multimedia publishing company specializing in training products for PC software.

One year, the company faced a dramatic drop in sales due to the delayed introduction of Windows 95. Because Microsoft had touted the new product as "revolutionary," Soft-Teach’s customers held off buying new training products until the operating system was finally released.

"I was afraid my people would start bailing," Anderson remembers, "but except for people moving out of area, only one person left during that period, and he returned three months later. I attributed that record to the openness with which we discussed our prospects for turning the situation around and the effort that everyone put into keeping everything open."

Temptation #3 — Hurry

Executives in high-tech start-ups are under constant time pressure. Some consider the ability to make decisions quickly to be the sine qua non of being a senior manager in a start-up firm. The problem is that convincing research evidence indicates that time pressure dulls one’s ethical wits. We saw that effect in the Kroll study, which cited the rapid pace of Internet investing as contributing to an environment that was fertile ground for fraud.

Other studies have shown that hurried decision makers become insensitive to the needs of others and tend to ignore the impact of their decisions on employees. In their book Decision Making: A Psychological Analysis of Conflict, Choice and Commitment, (Free Press, 1977) Leon Mann and Irving Lester Janis coined the term "hypervigilance" to describe the state of managers making difficult decisions under severe time pressure. As Mann and Charlotte Tan describe this state in later research, hypervigilant decision makers are prone to "deterioration of thinking and judgment, a narrowing perception of options, an incomplete and haphazard search of information, vacillation and, finally, an impulsive choice, sometimes before the deadline."

Much hurry is self-induced, and the temptation to give in to it is seductive. Some executives give into time pressure in a futile attempt to gain control of their situation. However, real control requires the exercise of patience and persistence—traits of character that virtue scholars directly relate to the cardinal virtue of courage. Being patient requires the courage to wait, and being persistent requires the courage to endure—in other words, controlling the temptation to hurry. Courageous executives do not work at a pace dictated by the moment; they work at a pace that permits them to be at their best.

Temptation #4 — Playing the Endgame

The final temptation facing executives of high-tech start-ups arises when the firm is about to be sold or to undergo a major change in ownership structure. At such times, some executives succumb to the temptation of ending their companies poorly. Some negotiate the terms of the end selfishly. Others fall prey to the temptation to cut some people out of the new regime, knowing they will never have to look these employees in the eye or work with them again.

There are no simple formulas for ending an enterprise ethically from an employee standpoint. Endings of all kinds require the utmost in wisdom, and once again, wisdom is a cardinal virtue. Wise executives manage endings so that they avoid employee betrayals in spite of the temptations to create them. They find ways to end an enterprise without taking the life out of it.

Genuine executive virtue was evidenced in the actions of Kingston Technology’s owners David Sun and John Tu when they sold 80 percent of their business to Softbank Corporation in 1996. Rather than pocket the entire $1.5 billion selling price, Sun and Tu decided to share their good fortune with Kingston’s employees. Although they were under no legal obligation to do so, the executives set aside $100 million for the employees. That translated to a bonus of $75,000 per employee, including secretaries and maintenance personnel.

On the Development of Executive Virtues

The cardinal virtues are not inherited, nor do they accrue automatically to those who rise to executive positions. Character develops by acting morally until it becomes a habit, a natural disposition to be good. Three factors facilitate this development: practice, role models and reflection.

Practice means engaging with a rich and diverse set of experiences. After all, one cannot possibly become courageous without being exposed to the situations that demand it. One of the problems during the recent surge in dot-com start-ups was that many lacked experienced executives at the helm.

Employees who staked their claims with these start-ups paid the price for their boss’s lack of moral readiness. One was a 20-year-old student of mine who was strung along with exaggerated promises until the firm was forced into an austerity program by its investors. Burned by this episode, my student now intends to cultivate his own experience before embarking on a high-tech start-up of his own.

The cultivation of virtue is also facilitated by the presence of role models who demonstrate virtuous dispositions through words and deeds. These can be teachers, colleagues or mentors. Floyd Kvamme, senior partner with the venture firm Kleiner, Perkins, Caufield & Byers, has mentored more than 30 Silicon Valley start-up CEOs. A former chair of the Markkula Center for Applied Ethics Advisory Board, Kvamme is well aware of the ethical stumbling blocks endemic to the high-tech environment. He modestly claims his remarkable record is testament only to his advancing age, but the CEOs he has tutored acknowledge his influence on their moral development.

Yorgen Edholm, co-founder and CEO of Brio Technology, is one such executive. As an example, he cites a personnel decision about which he sought Kvamme’s advice. "I felt the person was doing the wrong thing, but I wasn’t sure about bringing it up to the board. I didn’t want to make the other person feel bad. Floyd asked questions, drilled down in areas that I hadn’t even considered. He made me see I had a decision that was really a very significant issue for the company."

In this, and in other decisions, Edholm says Kvamme was clear: "This was a principle. There was an easy way out and a hard way out, but the hard way was the best way to deal with [the problem]. When you hear how he focuses on what is important—not fluff—you see that ethics takes courage because frequently it is not the expedient solution. Going with what was right may have taken longer and been painful, but I was surprised by how powerful that was for everyone in the organization—to see that the right thing was done."

Finally, reflection often boosts the development of executive character. By actively contemplating the meaning of justice, temperance, courage and wisdom in their lives, executives can become more perceptive of the opportunities to express these virtues. Moreover, reflection can unleash the potent force of imagination, which brings fresh perspectives to the temptations entrepreneurs face.

Recognizing the role of executive reflection in the development of virtue, Andre Delbecq, Santa Clara University professor of management, has recently founded the Institute for Spirituality and Executive Leadership at SCU. This institute will assist executives in exploring their own reflective potential through ecumenical spiritual exercises.

Litmus Tests of Executive Character

How can the concept of executive character help a person decide whether to work for a high-tech start-up? Rather than judging one’s prospects by looking for ethical abuses, I would recommend focusing on any evidence of executive virtue.

Are the founders experienced? Do they have a reputation for justice, temperance, courage and wisdom? Do they seem prepared for the character tests required by the temptations created by tree rings, candor calibrations, hurry and the endgame?

More fine-grained considerations include whether executives approach tree-ring distinctions as muted categories or rigid castes. Similarly, one can observe how often company news comes as a surprise to existing employees. In addition, prospective employees can judge whether the executive team seems harried and addicted to fire drills and crises. Finally, one can look at how executives ended their involvement with other start-ups they headed. Did they finish gracefully or in a way that excluded those who continued working for the firm?

Rajal Oswal found his new job as a market manager for CenterBeam in just that way. Oswal had left another start-up company not because he didn’t believe in the product but because he lost faith in the CEO’s management and his wildly optimistic scenarios.

"When I was considering taking a new job at CenterBeam, the first thing I looked at was who the CEO was," Oswal says. "From [being disappointed in the past], I knew I wanted to see what experience the management team had…. The CEO had a great track record."

Too many people consider ethics a matter only of moral minimums. But by assessing the moral maximums in executive character, prospective employees can better ascertain whether going to work for a high-tech start-up is worth the risk.

Dennis Moberg is Presidential Professor of Ethics and the Common Good in the Department of Management at Santa Clara University.