When Lack Of A Red Flag Is A Red Flag

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An analysis of more than two million whistleblower reports at publicly traded U.S. companies finds that companies with more employee hotline reports perform better, are generally healthier and attract fewer negative headlines.

The slew of headlines surrounding leaks, lawsuits and whistleblower reports at U.S. corporations paints a grim picture of the many failures of management across industries. But a George Washington University professor, Kyle Welch, and colleague Steve Steuben, a University of Utah researcher, have found that an increase in whistleblowing isn’t indicative of an increase in fraudulent activities or other corporate wrongdoings—it, in fact, can be a sign of healthy corporate practices.

In the fall of 2019, Welch and Steuben partnered with NAVEX Global, one of the largest providers of internal third-party whistleblowing systems, on a study that would compare employee hotline data from thousands of publicly traded U.S. companies with their financial results, regulatory and legal dealings and the bad press they receive. Their analysis found negative associations between the number of secondhand reports and negative outcomes, including lawsuits and government fines.

“The firms with more reports have fewer material external lawsuits and lower settlement amounts for those lawsuits. They have fewer fines and lower amounts for those fines,” Welch says of the findings of the analysis, which was controlled for company size and industry variations.

This research corroborates the fact that whistleblower reports are a highly valuable component of compliance programs, one that can not only mitigate the negative consequences of wrongdoings but also afford boards and management teams an opportunity to identify and address issues before they become more costly to the firm.

“The reality is that the more reports you have doesn’t mean that you have more problems. The more reports you have means the more information you have to get ahead of problems,” the George Washington University professor says.

According to Welch, employee hotline reports are often the only way for boards to get unfiltered information that goes around management—and the best way to capture fraud, corruption and other issues going on within the organization.

“Lehman brothers had a great board, with incredibly savvy, well-accomplished people that you would entrust monitoring almost anything….but the scenario analysis that ended up being [a warning sign] was filtered from the presentation that was given to the board,” he notes. “Where you’re handicapped as a board member is all your information is typically handed to you by the person you’re intending to monitor. The nice thing about whistleblowing is it’s a direct line to the front line about problems going on.”

He says directors who consider a high number of reports as a concern should look at the situation through a different lens. “You always want more reports instead of less. Directors who look at the data might wonder ‘How can we get the reports down?’” he says. “Well, it’s very easy to get the number of reports down. All you have to do is change the phone number and not tell anybody. That doesn’t mean you don’t have problems. That just means you have no reports.”

He says instead, directors should request comprehensive benchmarking reports that compare their company’s whistleblower program outcomes to those of peers across a variety of factors, including size, industry and geographical location, and determine whether the lack of red flags is, itself, a red flag.

“If you look at, say, East Asia, and have zero reports, well, if you talked to compliance officers that have been around the block, if you have zero reports, you have problems,” he says. “So, you should send your internal audit team out there and have them investigate.”

The Telephone Game

One of the study’s key findings is in the value attributed to secondhand reports and those containing the least amount of information in detecting wrongdoings or potential risks. Although firsthand reports typically contain more information than secondhand reports, and the information they contain is presumably more accurate because it comes from direct knowledge of the reported activity, the researchers found that secondhand reports are more often substantiated by management.

The findings are somewhat counterintuitive, since numerous other studies have shown that the person closest to an event is more likely to have more accurate information. But Welch says in this context, reality tells a different story.

“The common sense of the telephone game, where you’re closer to the event, has been proven in psychology research over and over again: firsthand accounts are always going to be better than secondhand accounts,” he says. “But we ran these regression analyses and found secondhand reports are 48 percent more likely to be substantiated by management than firsthand reports.”

He says that while, from this research’s perspective, he cannot reach a conclusion for the rationale behind this finding, there is a possibility that either firsthand witnesses of an event do not come forward for fear of retaliation—thus making secondhand reports the only source of information about activities where it is especially costly for an individual with firsthand knowledge to step forward—or that there are more frivolous firsthand reports than secondhand reports.

He explains: “There’s great stuff in firsthand reports, but there’s a filtering that happens with secondhand reports. The average person doesn’t want to submit a report about a problem. So, if you’re secondhand, it has to be something serious that you’re witnessing or you think you’ve witnessed to cause you to submit a report, so secondhand reports are more indicative of more significant problems.”

If fear of retaliation is also a reality, the analysis shows that the number of retaliation instances as a percentage of reports received is, in truth, incredibly small. What’s more, the study shows whistleblower reports are being taken seriously at the management level, with the average report being accessed six different times in its review.

Welch says these numbers show that most senior management teams are not being complacent about employee reports, “however there are bad apples—managers that don’t see this as a tool but as a liability—and that’s when it goes public,” he says. “And that’s, unfortunately, the only story that we end up hearing; the story of the great managers using these systems to solve problems doesn’t get told.”

Download the full study.

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