Holy Grail: Study Ties Internal Reporting, Business Outcomes

Important new academic research published this week empirically confirms something most corporate compliance officers have long suspected: a clear correlation between more internal whistleblower reporting and better business outcomes.

The research, from George Washington University and the University of Utah, examined anonymized whistleblower hotline data compiled by NAVEX Global. Basically, the researches devised several benchmarks to measure how actively companies use their internal reporting systems. Then they compared that activity to business outcomes such as lawsuits filed against the company, earnings management, employee complaints to external regulatory agencies, and even business productivity.

More internal whistleblower activity, they found, correlates to fewer material lawsuits against the company, lower litigation settlement costs, fewer whistleblower complaints to outside regulators, less potential for earnings management, and even higher return on assets.

NAVEX has published its own paper on the research — and in full disclosure, NAVEX paid me to write it. You can also download a copy of the original academic paper on the research, which GWU business professor Kyle Welch (the lead author) and his colleagues published earlier this week.

First, the good stuff that correlates to more internal reporting activity:

• Fewer material lawsuits. Companies with higher levels of reporting were subject to 6.9 percent fewer pending material lawsuits in the subsequent three years than those with lower levels of activity.
• Lower litigation costs. When material lawsuits were brought against companies, those with higher hotline usage faced 20.4 percent less in total settlement amounts.
• Fewer external whistleblower reports. Companies with more internal reporting activity experienced fewer external reports to the Occupational Health & Safety Administration (which receives whistleblower reports under Section 806 of the Sarbanes- Oxley Act) in subsequent years.
• Greater profitability and productivity, as measured by return on assets (ROA), a commonly used financial productivity metric. Companies with higher levels of reporting activity had ROA than comparable companies with lower levels of hotline activity.

And the bad stuff that correlates to companies with less internal reporting activity:

• Weaker governance practices. Companies with lower-level hotline activity rated poorly on the Bebchuk Entrenchment Index. This index measures governance practices such as staggered boards, limited shareholder rights, and golden parachute payments for senior executives; all of which correlate to lower rm valuations.
• Increased potential for earnings management. Firms with lower-level hotline activity also tend to claim “discretionary accruals” (an indicator of earnings management) more often. Further, companies with more discretionary accruals, also tended to see more external whistleblower reports in subsequent years.

Internal Reporting Implications

To be clear, this report doesn’t say more internal reporting causes better business performance; it only correlates to those better outcomes. We can’t say whether well-run companies create the conditions that lead employees to raise internal reports more often; or whether companies that encourage more reporting create the conditions that cause them to be well-run.

On a practical level, however, compliance officers don’t need to answer that question. The researchers found no scenario where more internal reporting led to diminishing returns. That is, there was no threshold of “too much reporting,” where business outcomes started to get worse. Any increase in whistleblower activity is therefore something you want to see, because it correlates to other things you want to see.

This is enormously useful research for compliance officers to have, because of the simple concept it proves: whistleblower activity is a barometer of how willing employees are to speak about organizational problems — and the more easily a company talks about its problems, the more it can solve those problems. Any corporate board worth its salt would jump on that concept immediately.

Consider the same dynamic in terms of a family. In Family A, everyone keeps their problems private and tries to solve them alone: the husband with a gambling addiction, the wife struggling at work, the daughter stressed about academic performance, the son bullied at school. In Family B, everyone brings those issues to the dinner table every night, even if they can’t solve the problems immediately.

Which family do you think will do better over the long run? Which one would you rather be in?

Whistleblower activity is a barometer of how willing employees are to speak about organizational problems — and the more easily a company talks about its problems, the more it can solve those problems.

There is much more to unpack in this research, so we’ll have more in future posts. This is plenty to get us started.

FAQs About This Research

Q: Did NAVEX share my company’s confidential complaint data with these researchers? I’ll skin them alive if they did.
A: Absolutely not. The researchers only saw anonymized data, with all personally or company-identifiable information removed. They only saw certain data fields, through secure connections, and never saw the substance of any specific complaint at all.

Q: Did NAVEX pay the researchers to look at this issue or subsidize their work in any way?
A: Other than letting them view the data, no. Welch, the lead investigator, approached NAVEX first to propose the collaboration, without solicitation on NAVEX’s part. Nobody had any idea what the final results would be when the project began.

Q: OK, it’s interesting material. What should I do with it?
A: This is great material to share with your board and C-suite, to convince them of the basic finding: that more internal reporting activity is always better, because it indicates employees’ willingness to alert management to problems.

On the practical level, the findings can also guide a compliance officer’s thinking about how to build and operate a compliance function. If generating more internal reporting is always the goal, then you can start to think more specifically about policies, procedures, messaging, and training to do that. It’s the standard against which you can assess your program’s evolution.

Q: Where can I learn more about what Welch and his team actually did?
A: NAVEX is hosting a virtual conference on Nov. 8, where Welch is a keynote speaker. He’ll be walking through the research and findings there, too. You can register on NAVEX’s website.