Fifty Shades Of Corporate Culture – New Study On Ashley Madison And Unethical Corp Behavior
Fifty Shades Of Corporate Culture
William David Grieser
Tulane University
Nishad Kapadia
Tulane University – A.B. Freeman School of Business
Rachel Li
Michigan State University
Andrei Simonov
Michigan State University – Eli Broad Graduate School of Management; Centre for Economic Policy Research (CEPR); Gaidar Institute for Economic Policy; SITE
May 13, 2016
Abstract:
We develop a new measure of integrity as it relates to corporate culture – the number of employees who use corporate emails to register for a website that facilitates extramarital affairs. This measure is associated with firm-level unethical behavior: it predicts a greater probability of SEC enforcement actions for accounting misstatements, and lower corporate ethics ratings by external analysts. However, consistent with research in psychology, we find that the measure also predicts more innovation (R&D intensity, successful patenting rates, subsequent patent citations, and patent diversity) and risk-taking (leverage, volatility, probability of default). Our results suggest that it is difficult to engineer a perfect corporate culture due to potential trade-offs between employee creativity, risk-taking, and integrity.
Fifty Shades Of Corporate Culture – Introduction
“…Enron, where the prevailing corporate culture was to push everything to the limits: business practices, laws and personal behavior…This culture drove Enron to dizzying growth, as the company remade itself from a stodgy energy business to a futuristic trader and financier. Eventually it led Enron to collapse under the weight of mindbogglingly complex financial dodges.” — The Wall Street Journal August 26, 2002
Managers often claim that having an appropriate culture is critical to a firm’s success.1 Recent research in financial economics and accounting claims that this attention to culture is not misplaced. Guiso et al. (2015) find that employee perception of top management integrity is associated with strong firm performance and Garrett et al. (2014) find that it is associated with higher quality financial reporting. However, if a culture of integrity is value-enhancing, why don’t all firms have such cultures? In this paper, we investigate the possibility that inherent trade-offs make it difficult to engineer a corporate culture. For example, the above excerpt suggests that Enron’s aggressive, risk-taking culture was responsible not only for its initial success, but also for its ultimate failure. Research in psychology and behavioral economics finds a trade-off between ethics and creativity at the individual level (e.g., Gino and Ariely (2012)). In this paper, we investigate whether a similar trade-off between creativity and ethics exists at the corporate level.
Our measure of firm culture is based on a choice made by individual employees at the firm: the decision to register for and use AshleyMadison.com (“AM”), a website that facilitates extramarital affairs.2 We assign AM users to firms based on the domain name taken from their email IDs, restricting our sample to approximately 47,000 individuals who used their corporate email ID to register and actively use an AM account over the 2002-2014 sample period. Our key variable of interest is the number of active users at any point in time in a given firm, where active means the user has not only registered, but also exhibited some activity in the account (e.g. purchased credits to send a message). This is done to exclude “phantom” accounts that were created without the intention of being used.
Erhard et al. (2009) argue that “keeping one’s word” is an important component of integrity for individuals and organizations. Along these lines, Garrett et al. (2014), find that intraorganizational trust is associated with a lower likelihood of misstatements and better internal control strength. Using AM reflects a lack of integrity at the level of the individual employee, since the AM website encourages users not to keep their word to a significant other (the website’s slogan is Life is short. Have an affair). Because a firm is more likely to attract, select, and retain employees who match its culture (Schneider, 1987), we expect that individual employee traits provide information about corporate priorities. Firms that do not emphasize integrity in their cultures are more likely to employ individuals who display a lack of integrity. Thus, we hypothesize that greater AM membership within a firm signifies that the firm’s culture does not emphasize integrity, or at least that the firm does not monitor employees very carefully.
As a first step, we validate the hypothesis that AM membership provides information on corporate ethics. We find statistically significant and economically meaningful evidence that a higher rate of AM membership predicts worse outcomes for two measures of ethical behavior (a) KLD ratings of firms on ethical issues by external analysts and (b) SEC enforcement actions due to accounting misstatements. After controlling for firm size, geography, and year fixed effects, we find that a one standard deviation increase in AM membership is associated with a .132% increase in the probability of an accounting misstatement over the following year, which corresponds to 19.1% of the unconditional mean and 29.5% of the mean for firms without AM membership. Similarly, a one standard deviation increase in AM membership is associated with a 2.6% increase in analysts perception of significant concerns regarding bribery and corruption. This effect is economically quite large, as the unconditional average is only 4.7% and the average for firms with no membership is 2.2%. AM membership’s predictive ability for both measures of ethics remains after controlling for a large number of observable factors, including past firm performance and governance measures, as well as industry, year, and geography fixed effects. Thus, the individual actions of a firm’s employees signing up and using AM reveals the likelihood of unethical behavior at the corporate level.
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