I have long articulated that companies that have robust compliance programs are more efficient, better run and more profitable organizations. This has been borne out by reports, such as those put out annually by Ethisphere, noting that the companies that appear on its annual World’s Most Ethical company awards list consistently out-perform the S&P 500 index. However we now have specific data which demonstrates that companies who use the tools of a best practices compliance program do better financially. In other words, good compliance adds to, and does not subtract from the bottom line.
Last week, in an academic paper (the Report), entitled “Evidence on the Use of and Efficacy of Internal Whistleblowing Systems”, Stephen Stubben and Kyle T. Welch demonstrated that companies that have strong internal reporting systems tend to have (1) greater profitability and workforce productivity; (2) fewer material lawsuits brought against the company and lower settlement costs if a lawsuit does occur; and (3) fewer external whistleblower reports to regulators and prosecutors. This documented evidence once again shows not only why a stand-up/speak culture is so powerful but points directly to the issue of corporate culture and organizational justice.
The Report studied data from NAVEX Global Inc’s (for whom I blog and write) internal hotline and reporting data, which was appropriately anonymized. The data, over 3 million reports dating from 2004 by over 5000 public companies, included the date of the report, the type of report and the number of times the report file was accessed by management, how the reporter became aware of the activity and the outcome of the company’s investigation. This information was compared against material lawsuits filed against the companies in the study. The Report noted, “one standard deviation increase in the use of an internal WB [internal reporting hotline] system is associated with 6.9% fewer pending lawsuits and 20.4% less in aggregate settlements.”
Bob Conlin, NAVEX Global President and Chief Executive Officer (CEO), said in a Press Release, “With this new study, compliance officers now have the first empirical, independent evidence that investment in compliance brings a material advantage to the organization. Executive leadership and board members can start to consider the hotline reporting data as a key indicator of workplace culture.” Report co-author Welch said, “Companies with higher levels of whistleblower activity suggest a healthier workplace culture; one that helps management identify and address concerns before they become more costly to the firm.”
The Report made four primary findings. First, companies that tend to have robust internal reporting cultures, leading to more internal reports “are more profitable on average, and firms less actively using internal WB systems tend to be growing more quickly and have weaker corporate governance.” This leads to insight No. 2 that growing firms “are more likely to misstate financial results” and that more robust internal reporting systems can help to ameliorate the likelihood of financial reporting. Of course it is well known that the group who is best suited to uncover corporate fraud are a company’s own employees and the Report adds “to these findings by exploring how capture this resource for managers.”
The next insight is that robust internal reporting tends to spot and then allow for remediation of issues before they become full blown legal violations. The Report states, “Our results are consistent with the idea that internal WB systems can be a tool within firms for discovering and resolving issues before they become increasingly complex and costly.” (As in go to a regulator or a lawsuit is filed.) The flip side to this finding is that if there is an internal report and remediation it leads to less reports to regulators. The Report noted, “We also find that an increased number of complaints filed internally is not associated with more external complaints”.
Finally, the Report notes implications for regulators and the desire to encourage internal reporting. Just as the Securities and Exchange Commission (SEC) understood the desire for a whistleblower to report internally first, to give the company time to assess and remediate the reported issue; the Report confirms the advantages to companies for employees who report internally before reporting externally to regulators. Yet the Supreme Court did away with this clear incentive in its Digital Trustdecision in doing away with Dodd-Frank whistleblower protection for those employees who do report internally initially. The Report stated, “Our study informs both firms and regulators of the potential value of internal WB systems, some of which may be lost with increased incentives to report externally.”
Not many senior managers or Boards of Directors understand that compliance is not a cost function but a cost savings function. Yes it does cost some money to put in a hotline but if your company is a public company, you are required by law (Sarbanes-Oxley) to have one. It is a sunk cost. But if your organization can turn this sunk cost into a cost savings then it is a big win for all concerned. The cost savings the Report focused on was material lawsuits. What does that mean? The cost of the lawsuit had to be material to an organization. What is that number 5%; 10% or something else? Whatever it is, that number is quite high.
All of these findings make clear that companies which value their employees raising their hands and speaking up will be better run, more profitable companies. It is not simply about reporting bribery, corruption and fraud when you see it or even stumble across it. It is about having a culture which values employees input and insights because those inputs and insights are what can make a company run more efficiently and more profitably. It also includes companies which make it clear that employees who do speak up will not be sanctioned or retaliated against going forward. For if you fear for your (corporate) life when speaking up, there is probably little chance that you have people speaking up.
Lastly, it all ties into corporate culture. Companies which encourage and even celebrate employees who speak up are companies that treat employees fairly and have clear institutional justice. Culture and institutional justice drive behaviors far beyond whistleblowing. They drive a company’s reputation and how it is treated in the marketplace. The Report is welcomed documented evidence of the effectiveness of one component of a best practices compliance program.
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