Corporate integrity undermined by the pursuit of shareholder value

2014

Cynics who insist that corporate ethics policies are often not worth the paper they are written on often cite the fact that the final edition of Enron's 64-page "Code of Ethics" was published in July 2000, less than 18 months before the storm of scandal broke over the company that led to its downfall.

In the foreword to the booklet, Chairman Kenneth Lay (who, remember, was later found guilty of 10 counts of fraud) wrote that "we want to be proud of Enron and know that it enjoys a reputation for fairness and honesty and that it is respected".

More than a decade later, some 85 per cent of U.S. S&P 500 companies have some sort of statement of principles and values on their websites – and many of them like to trumpet these in public. But when a team of economists tried to tie the frequency and prominence of these values to measures of short and long term performance, they found no any significant correlation.

Instead, Luigi Zingales, a professor of finance at the University of Chicago Booth School of Business, and colleagues Luigi Guiso of the Einaudi Institute for Economics and Finance, and Paola Sapienza of the Kellogg School of Management, found that it is those companies which are perceived by their own employees to value ethics - not necessarily those that advertise their ethical culture to outsiders - that showed higher profits and other indicators of strong performance.

Their study "The Value of Corporate Culture," looked at how companies described their integrity and ethical approach on their websites and compared this to responses to surveys conducted by the Great Place To Work Institute, which publishes an annual list of the "100 Best Companies to Work For." The data included responses from employees at 1000 public and private firms between 2007 and 2011.

"We find that high levels of perceived integrity are positively correlated with good outcomes, in terms of higher productivity, profitability, better industrial relations, and higher level of attractiveness to prospective job applicants," Professor Zingales said.

The researchers then posed an obvious question: if a culture of integrity is valuable, why do some firms end up losing it?

To answer this, the team looked at how different governance structures impact the ability to sustain integrity as a corporate value. And the results were illuminating.

"Previous research has found that companies included in the 100 Best Companies to Work For list tend to over-perform the market," said Zingales. "We can interpret this result as saying that the market initially underestimates the value of the integrity capital, which plays a big role in the 100 Best Companies to Work For index. Only as the profits come in – the market appreciates the value of integrity."

In other words, the researchers surmised, publicly-traded firms will tend to under-invest in integrity capita, at least in the short term.

To test this hypothesis, the study compared the level of integrity of otherwise similar publicly traded and privately held firms. Even after controlling for differences in industry, geography, size, and labour force composition, publicly-traded firms were found to be less able to sustain integrity.

"Besides being listed, we find that the only statistically significant corporate governance characteristic is the presence of a large shareholder (with a least a five per cent ownership share), which has a negative correlation with the level of integrity. Thus, it looks like an excessive focus towards shareholder value maximization might undermine the ability of a company to sustain a high level of integrity capital," Zingales said.

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