Whenever a company is accused of fraud, there’s usually speculation about whether or not its company culture enabled wrongdoing. Is there a link between good and bad company culture and corporate financial fraud?
According to a new study, the surprising answer is yes -- companies with better culture and more satisfied employees are less likely to engage in fraudulent financial activity.
Looking through the Glassdoor
In their study, Corporate Culture and Financial Reporting Risk: Looking Through the Glassdoor, researchers Kyle Welch, Oded Rozenbaum and Yuan Ji of George Washington University and Hong Kong Polytechnic University used company reviews data from Glassdoor to study the connection between company culture and fraud. The results highlight a strong connection between culture and fraud -- and it appears that poor company culture is statistically linked to more deceptive financial reporting.
The researchers looked at three measures of company culture in data submitted by Glassdoor users between 2008 and 2015: the rating of an employer’s culture and values, the rating of its senior leadership, and its overall rating. Then they analyzed the relationship between those measures of culture and the odds that the federal government investigated each company for fraud.
After controlling for many company characteristics that could influence accounting practices and employees’ opinions, they find that poor culture predicts that companies are more likely to be investigated for fraud by the U.S. Securities and Exchange Commission.
Why Poor Culture is Linked to Fraud
How does poor company culture lead companies into legal trouble? One theory is that companies with dysfunctional cultures set unrealistic goals and try to push workers to meet them. According to the authors, “[a company culture] that sets overly aggressive targets and is intolerable to failure… can promote employee dissatisfaction, instill pressure to commit fraud, as well as rationalize doing so.”
A second theory is that companies with poor company culture may lack internal institutions that serve as safeguards against fraudulent behavior. In most companies, what accountants call “internal controls” prevent employees from engaging in questionable financial practices. But when those controls fail, good company culture can work as a safety net. According to the authors, “a rigorous corporate culture—such as one that promotes ethical conduct or whistleblowing—can decrease opportunities to commit fraud.”
What Can Companies Do?
Although poor company culture is statistically linked to corporate fraud, the authors argue that it’s possible to break that link. The researchers find good corporate governance can protect companies against poor culture. For companies with a large share of independent directors on their board or that have a large number of financial experts on their audit committee, the relationship between culture and fraud is weaker. It is possible to break the link between poor culture and financial misreporting, but the study suggests that it takes strong oversight.
The study’s results suggest that managers shouldn’t dismiss employees’ complaints about culture. If managers don’t listen to employees’ feedback and attempt to correct the problem, a dysfunctional culture could lay the foundation for an accounting scandal down the road. Monitoring employees’ perceptions of culture to make appropriate changes can payoff in more satisfied workers, and also in more accurate financial reports.
Read the full study, “Corporate Culture and Financial Reporting Risk: Looking Through the Glassdoor,” by Yuan Ji, Oded Rozenbaum and Kyle Welch at SSRN.