Ever worked in a company that required you report ‘near miss’ events? That is, events that could have or nearly did result in an accident. The rationale is straightforward; an open reporting culture and investigating the near misses should help avoid the real thing, which at the extreme can be both fatal and catastrophic. In heavy industries where safety is critical, ‘sweating the small stuff’ is important.

Slightly different, but there are safety parallels in a recent study* which looked at whistle-blowing data from US listed companies. A requirement of many markets (for example, Sarbanes-Oxley in the US), whistle-blower systems are intended to provide a secure and anonymous means to report issues and provide an alternative to the traditional reporting and monitoring mechanisms that companies employ. And they are important, because employees, as insiders, are best placed to identify inappropriate behaviour within a company*.

What did the study find? In a nutshell, evidence of more whistle-blowers is a good thing at a company. Counterintuitively, more internal whistle-blowers doesn’t mean more (frequent or serious) problems. Rather, it showed (in US companies at least) that the more employees use internal whistleblowing hotlines, the less lawsuits companies face, and the less money they pay out in settlements. Use of whistle-blowing is actually a sign of open and effective communication channels; employees believe that problems will get sorted. Conversely, it’s not hard to imagine that when management abuse these processes (insert name of UK-listed bank here), this belief is eroded. Avoid the ‘accident’ (and the associated public relations disaster), address internally and learn from your mistakes.

And from a governance perspective, did the study identify any particular company traits? Yes. Autocratic executive management teams with governance protocols that limit minority shareholders are less likely to pay heed to these systems. As are fast growing companies (where other studies have shown that accounting misstatements are more prevalent) which is important for us to bear in mind given our focus!

Finally, remember, this is for companies in the US, a nation which psychologists and sociologists would classify as having ‘low power distance’*. Psycho-babble what? Power distance is the ‘extent to which the lower ranking individuals of a society accept and expect that power is distributed unequally’*. This been measured on a country by country basis and it has been found that many developing countries have ‘high power distance’. To stretch the safety parallels to their limits, safety stats in developing markets often look great. At face value, the data says, ‘nothing to see here’. But accidents often go unreported because employees are (more) respectful and submissive to their employer. Taiwan, India, Japan et. al all require whistle-blowing systems and processes like the US does, but I imagine the hotlines in these countries probably don’t get a lot of calls.

In case you were in any doubt, open and honest corporate cultures work best. If management teams are targeting ‘zero’ whistle-blower reports they are missing the point.

*Stubben, S. and Welch, K.T, (2018); Evidence on the Use and Efficiency of Internal Whistleblowing Systems
*Dyck, A., Morse, A., and Zingales, L. (2010); Who blows the whistle on corporate fraud?; The Journal of Finance; 65(6), 2213-2253.
*Outliers: The Story of Success; Malcolm Gladwell (2008)
*https://en.wikipedia.org/wiki/Power_distance

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.

*As at 30 November 2018.

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