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Research team examines HealthSouth scandal, recovery

Management faculty members, from left, Achilles Armenakis, Brian Connelly, Alan Walker, and graduate student Scott Heyler, investigate ethical practices within organizations.

Why do corporations behave unethically? Is it the desire to turn a greater profit? Is it out of fear – a mechanism used to mask weakness or a desperate move to temporarily prevent financial distress?

Achilles Armenakis, James.T. Pursell Eminent Scholar in Ethics and Director of the Center for Ethical Organizational Cultures at the Raymond J. Harbert College of Business, provides insight into corporate behavior in his research “Forensic Diagnosis and Transformation of an Organizational Culture,” which specifically examines the HealthSouth Corporation scandal and reorganization from 1984 through 2011.

Armenakis teamed with research fellow and graduate assistant Irene Lang on the paper, which was submitted in July to the Journal of Change Management.

The study focuses on Birmingham-based inpatient rehabilitative hospital HealthSouth, its former CEO Richard M. Scrushy, and the measures the company took to change its organizational culture after Scrushy and 16 executives faced accounting fraud charges totaling $2.7 billion in 2003.

Scrushy, the first executive to be tried under the Sarbanes-Oxley Act of 2002 for altering financial returns at the company he founded, was acquitted of those charges in 2005. In an unrelated case, he was convicted of bribery, conspiracy and mail fraud later that year.

“HealthSouth, WorldComm, Enron, Bernie Madoff … people who were perpetuating the fraud were the top guys and they were doing it because of greed,” Armenakis said. “The fraudulent behavior at HealthSouth was unforgivable. People who were doing it knew better. The culture in that part of the company was ‘you have to do this for the family.’ Those people were duped into doing it and they paid the price.”

‘Identify the importance of an organization’s culture’

The HealthSouth case study represents one of many research pieces made available to corporations by the Center for Ethical Organizational Cultures, founded in 2007 and funded by Sylacauga, Ala., businessman, philanthropist and inventor James T. Pursell, Sr., a 1952 Auburn business graduate.

iStock_000016707944XSmall“The main thing (for the Center) is to identify the importance of an organization’s culture in influencing ethical and unethical decision-making,” Armenakis said. “To my knowledge, our center is unique. We’ve got funding that is specially-earmarked for ethical research.”

Armenakis believes that if companies desire to learn more about ethical practices, they can draw on the Center and its resources for help. Armenakis welcomes consulting projects for the Center and invites firms and their executives to explore their research on ethical practices and integrate them into their own corporate cultures. The Center’s research is often published in peer reviewed journals.

“What we want to do is alert organizations that it’s possible this stuff is going on and you don’t know about it,” Armenakis said. “Had they done this at HealthSouth, all of this could have been avoided. Some CEOs want to deal with it only if it becomes a problem. They are being reactive, not proactive.

“The most logical organizational location for any culture to develop is the highest levels, at the top. Then it cascades downward. That’s where the culture starts. What we have are ways in which a company can investigate itself. If a company knows these things exist, it can do something about it.

“You can be attentive to unethical behavior going on and be alerted and do something about it and avoid another HealthSouth.”

The Center is composed of three faculty members: Armenakis, Assistant Professors of Management Brian Connelly and Alan Walker, and six graduate students.

“One of the emphases of the Center is it’s really a research center,” said Connelly, who researches inter-organizational trust and distrust, sustainability initiatives and transition economies. “It’s not just about the practicalities of special situations, but really about the bigger questions. It’s about micro-principles – creating ethical corporate cultures from individual-level responsibilities within each firm.

“On the flip side, and here’s where I come in with much of my research, it’s taking notice of ethics and overlaying it with firm strategy. At the intersection of ethics and strategy is corporate governance. It’s about creating structure – a mechanism designed to prevent organizational misconduct.”

Walker, who has researched the impact of ethical organizational cultures on employees’ ethical values, judgments, attitudes and behaviors, said the Center, “assesses ethical cultures of organizations.”

“Once you do that, you find regions or pockets that maybe the ethical culture isn’t where you want it to be,” he said. “We go in and help them assess that and come up with a reasonable plan to make it better.”

Walker said CEOs would be wise to seek out external ethics consulting.

“If you take shortcuts, it ends up hurting the organization and yourself,” he added. “You know the right thing to do, but will you follow it?”

A number of high-profile speakers, including current HealthSouth CEO Jay Grinney, HealthSouth Chief Compliance Officer Cleaster Ewing, and State Ethics Commission Director James Sumner, have addressed students on behalf of the Center since 2001.

High praise

Armenakis praised Grinney, who succeeded Scrushy in 2003, for making sweeping changes – which has helped the company grow while meeting ethical standards.

“He came in and terminated a bunch of the people that were involved (in the HealthSouth scandal),” said Armenakis, who noted that Grinney addressed Harbert Physicians Executive MBA students in 2011 about the ‘cultural change at HealthSouth’.

“Grinney separated the roles of the chairman of the board and CEO, hired a nationally-known ethics expert to the board, and he also hired a chief compliance officer who reports directly to him.

“He said, ‘We aren’t doing this anymore.’ They had a crisis they had to fix. In a crisis, you’ve got to act quickly.”

HealthSouth and the organizational culture of accounting fraud

Armenakis and Lang reported that HealthSouth succumbed to what they deemed as a flaw in “organizational culture.” According to their research, organizational culture is “an organization’s personality which determines how its employees carry out their activities.”

Armenakis and Lang report “four defining moments regarding the evolution of HealthSouth’s organizational culture before the FBI became involved:

  • (A) Accelerating the practice of aggressive accounting estimates in order to expedite going public
  • (B) Acquiring health care companies without conducting financial due diligence in order to fulfill the business philosophy that ‘bigger is better;’
  • (C) Violating U.S. Medicare rules which govern payment for rehabilitation services; and
  • (D) Fraudulently reporting financial and accounting information.”

“HealthSouth started falsifying records in 1996 and that’s the last time they made a profit,” Armenakis said, citing claims made by former HealthSouth CFO (1984-97) Aaron Beam in the book “HealthSouth: The Wagon to Disaster. “From 1996 through 2002, they falsified reports and paid more in taxes than they actually made in profits.”

Under new CFO Weston Smith, HealthSouth reported an inflated $4.5 billion in revenue in 2001.

Smith — who blew the whistle on HealthSouth to the authorities in 2003 — was sentenced in U.S. District Court in 2005 to serve 27 months in prison and pay $1.5 million in forfeited assets. Beam, who founded the company with Scrushy in 1984, was sentenced in U.S. District Court in 2005 to a three-month prison term, ordered to forfeit $275,000, was fined an additional $10,000, and given one year of probation.

Scrushy was acquitted.

But four months later, the former HealthSouth CEO was indicted on 30 counts of money laundering, extortion, obstruction of justice, racketeering and bribery in a case involving former Alabama Gov. Don Siegelman. He was incarcerated from 2005 through 2012.

Scrushy didn’t escape the HealthSouth stockholders, either. In 2009, they won a $2.9 billion lawsuit in U.S. Civil Court.

Culture started from the top

Armenakis stressed that the company’s rehabilitation and services arm remained above board and created a positive culture and corporate image for the company as it grew from infancy in the 1980s and early 1990s. However, the “finance and accounting” arm created a different culture beginning in 1996 – a culture of fraud and deceit.

“One of the unique things is the bad guys were in one (HealthSouth) department – finance and accounting,” he said. “The professional services that were provided were doing very well. They (finance and accounting) built up their Medicare claims to get reimbursed and figured out a way to lie to the auditors.”

According to the report filed by Armenakis and Lang, “Initially, one or two executives made relatively minor decisions (exemplifying egoistic consequentialism), such as the practice of aggressive accounting … Consequentially, more individuals had to be brought into the egoistical consequentialism and engage in fraudulent behavior.

“… Finally, the actual falsification of reported earnings became necessary in order to beat the street. And, ‘being part of the family’ apparently meant that those individuals reasoned that ‘we must engage in this behavior for the sake of the family.’”

The report’s summary concluded that “organizational culture is known to influence the behavior of employees.”

In this case, according to the report, the culture of corruption began at the top.

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Joe McAdory

Joe McAdory is Communications Editor at The Raymond J. Harbert College of Business. Prior to his appointment at Auburn University in January of 2013, McAdory was Editorial Page Editor (2004 to 2013) and Sports Editor (1999-2003) at the Opelika-Auburn News. He has been recognized by the Alabama Press Association and Alabama Associated Press for his sports columns, news columns, investigative reporting and news features. He is a 1992 graduate of Auburn University.
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