How To Use Compensation To Encourage Whistleblowing

Given the recent global financial crisis, many companies have placed more restrictions on variable compensation, however the implications of this for whistleblowing has received limited research attention. A recent US study examined the relationship between stock compensation structures and monetary whistleblowing rewards, and to what extent they influence senior managers’ decision to whistleblow. The results of this study suggest that when employees have stock compensation that has vesting restrictions, they are more likely to blow the whistle than when they have stock compensation that does not have vesting restrictions. Whistleblowing was also found to be more likely as the reward offered for whistleblowing increased.

Key Topics: Whistleblowing; Variable compensation; Equity

Title of Reviewed Article: The Effects of Compensation Structures and Monetary Rewards on Managers’ Decisions to Blow the Whistle
 
Researchers: Jacob M. Rose (University of Wellington), Alisa G. Brink and Carolyn Strand Norman (Virginia Commonwealth University).
 
Publication: Journal of Business Ethics, 2016, May 2016 (Online Edition).

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Setting the Scene
 
Compensation structures have come under greater scrutiny on the basis that, particularly variable compensation, could lead to greater risk taking behaviour. This perception has led to an increase in regulation governing compensation in various industries which attempts to place a greater emphasis on long term success, and regulators and academics have often advocated the use of restricted stock as a long term incentive, which restricts the sales of stock in the short term (Bhagat & Romano, 2009; Bebchuk & Fried, 2010). Illustrating its increasing prevalence, between 2004 and 2010, executives in S&P 500 companies disclosed that their holdings of restricted stock increased by 88% (Petra & Dorata, 2012). The effect of this shift on whistleblowing remains unclear however.

Whistleblowing involves the highlighting of a company’s improper practices by employees or former employees. Research suggests that decisions to whistleblow involves a formal or informal analysis of the costs and benefits of taking such action (e.g. Rocha & Kleiner, 2005; Dasgupta & Kesharwani, 2010). Robinson (2012) found that such analysis is of particular importance when deciding to report financial impropriety by the company. Prior research indicates that compensation structures which include stock can discourage employees from whistleblowing as it could affect their financial wellbeing, as it is tied to the company’s stock price which could decline were they to whistleblow (Call et al., 2015). Further to this, evidence has been found to suggest that offering financial incentives for whistleblowing serve to encourage whistleblowing (Dyck et al., 2007; Dworkin, 2007).
 
Central to whistleblowing structures effectiveness is the willingness of employees to report impropriety. This study examines the relationship between various forms of stock compensation in determining whistleblowing intentions on detection of financial impropriety. The study also investigates the effect of reward size on whistleblowing intentions.
 
The researchers outlined three primary research questions:
 
Hypothesis 1 – “The likelihood that managers will blow the whistle will be greater when the size of the financial reward for whistleblowing is larger.”
 
Hypothesis 2 – “Managers receiving restricted stock compensation will be more likely to blow the whistle than will managers receiving unrestricted stock compensation.”
 
Hypothesis 3 – “The difference between intentions to blow the whistle when rewards are high versus low will be greater when the manager holds restricted stock relative to when the manager holds unrestricted stock.”
 
How the research was conducted
 
115 MBA students from a US University took part in this study. On average these participants had 5 years of professional work experience.
 
Participants were assigned to one of four study conditions, which manipulated compensation conditions, specifically the size of reward for whistleblowing and type of stock held (restricted or unrestricted stock). In these conditions participants were asked about their intention to whistleblow when faced with a hypothetical financial impropriety scenario in which, as managers, they had an opportunity to whistleblow.
 
Key Research Findings
 
The results indicated that the likelihood of whistleblowing is higher when rewards offered for whistleblowing are higher, thus supporting Hypothesis 1.
 
Hypothesis 2 was not supported, as results indicated that the type of stock, whether restricted or unrestricted, did not play a role in intention to whistleblow in this whistleblowing scenario.
 
The researchers did however find that intention to whistleblow was greater when reward offered for whistleblowing is greater and when employees received restricted rather than unrestricted stock, which supported Hypothesis 3.
 
Additionally, most participants indicated that they perceived the potential fraud presented to them as immoral, and felt some personal responsibility to report it. Participants also mostly indicated that they did not feel that whistleblowing would affect their reputation adversely.
 
Results Commentary
 
The results suggest that whistleblowing reward structures and company compensation structures combine in determining whistleblowing intentions. Reward size was found to significantly influence whistleblowing intentions when employees also held restricted stock but had less effect when employees held unrestricted stock.
 
This points to the fact that when employees are paid in unrestricted stock they have a greater disincentive to whistleblow as their actions could threaten the current value of their stock holding. On the other hand, it could be inferred from the results that employees receiving restricted stock do not have the same opportunity to sell their stock holding, and therefore will be more sensitive to the monetary reward on offer, as well as being more focused on the long term implications of whistleblowing.
 
Organizational and Reward Implications
 
This study establishes that both reward for whistleblowing and company compensation structures are factors that should be considered in determining an appropriate whistleblowing compensation strategy. This study is particularly relevant given the increasing prevalence of restricted stock as a compensation tool, as the results suggest that restricted stock encourages whistleblowing but alone may not be enough for actual whistleblowing to occur, without additional reward for whistleblowing.
 
Final Thoughts
 
As companies wrestle with designing compensation structures that encourage ethical behaviour as well as performance, the results of this study should be of interest to various parties, including compensation committees, regulators, and shareholders. There are a number of avenues future research could take to build on and support this study, including using a more applied group of participants in actual companies, as well as reviewing the interplay of additional types of compensation, and indeed, the interplay between the use of both restricted and unrestricted stock awarded to the same employees, as is prevalent in many companies.

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Source Article: Rose, J. M., Brink, A. G., & Norman, C. S. (2016). The Effects of Compensation Structures and Monetary Rewards on Managers’ Decisions to Blow the Whistle. Journal of Business Ethics.
 
Published by: Springer Science

For further details and access to the full journal article Click Here (subscription or payment may be required).

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References:
 
Bebchuk, L., & Fried, J. (2010). Paying for long-term performance. University of Pennsylvania Law Review, 158(7), 1915–1960.
 
Bhagat, S., & Romano, R. (2009). Reforming executive compensation: Focusing and committing to the long-term. Yale Journal on Regulation, 26(2), 359–372.
 
Call, A., Kedia, S., & Rajgopal, S. (2015). Rank and file employees and the discovery of misreporting: The role of stock options. Working paper. Columbia Business School.
 
Dasgupta, S., & Kesharwani, A. (2010). Whistleblowing: A survey of literature. The IUP Journal of Corporate Governance, 9(4), 57–70.
 
Dworkin, T., & Near, J. (1997). A better statutory approach to whistle-blowing. Business Ethics Quarterly, 7(1), 1–16.
 
Dyck, A., Morse, A., & Zingales, L. (2007). Who blows the whistle on corporate fraud? The Journal of Finance, 65(6), 2213–2253.
 
Petra, S., & Dorata, N. (2012). Restricted stock awards and taxes. Journal of Accountancy, 213(2), 44–48.
 
Robinson, S. N., Robertson, J. C., & Curtis, M. B. (2012). The effects of contextual and wrongdoing attributes on organizational employees’ whistleblowing intentions following fraud. Journal of Business Ethics, 106(2), 213–227.
 
Rocha, W., & Kleiner, B. (2005). To blow or not to blow the whistle? That is the question. Management Research News, 28(11/12), 80–87.