(James Saft is a Reuters columnist. The opinions expressed are his own)
By James Saft
April 26 While websites on which employees anonymously rate their companies are typically used by would-be hires, fund managers should pay close attention too.
A new study finds that employee surveys on company rating website Glassdoor can be used to find companies at higher risk of fraud and misreporting.
Corporate fraud and deceit, as a general rule, isn’t the result of individual bad apples but the poison fruit of a dysfunctional corporate culture. Enron is a prime example on the accounting side just as Wells Fargo, with its millions of fake accounts, shows how a high-pressure culture can lead to wrongdoing and damage to shareholders.
Indeed the Auditing Standards Board has identified three preconditions it labels “the fraud triangle”: employees who face pressure to meet benchmarks, who have the opportunity to commit fraud, and who can rationalize it away.
Yuan Ji of Hong Kong Polytechnic University and Oded Rozenbaum and Kyle Welch of George Washington University examined more than one million anonymous reports by purported employees of major companies on Glassdoor, theorizing that the way in which they rate their bosses, their company’s culture and their own job satisfaction might give insight into the likelihood of shenanigans at a given firm. (here)
The upshot is pretty clear: companies with unhappy employees with a low opinion of the climate at their firms and with contempt for their bosses are a red flag.
“We find that firms with lower levels of 'culture and values' (as measured by employees) and lower levels of job satisfaction are more likely to be subjected to SEC fraud enforcement actions and securities class action lawsuits. The same measures of corporate climate are also associated with an increased likelihood that a company will narrowly meet or beat market earnings estimates,” the authors write in a study released this year.
“Conversely, we find job satisfaction and positive employee opinions of senior leadership to be associated with lower abnormal accruals.”
Abnormal accruals are unusual accounting set-asides which can indicate danger in accounting practices at a company.
To be sure, there are reasons to treat the results cautiously, not least the possibility that it is disproportionately people with an axe to grind who go online and rate their companies.
Still the data, even when adjusted in a variety of ways, shows a link between how companies are rated on Glassdoor and how often they are named in securities class action lawsuits or are subject to SEC Accounting and Auditing Enforcement Releases.
These companies are also more likely to just meet or exceed analysts' expectations of their earnings, another thing which can be a marker that accounting is being 'gamed'.
Given indications that there are widespread problems with accounting, and moreover, the big impact it can have on firm value if fraud comes to light, this, or other similar data, is a set of indicators both investors and regulators may want to pay closer attention to.
A 2015 survey of almost 400 chief financial officers and finance executives found they themselves believe that a whopping 20 percent of firms “intentionally distort earnings, even though they are adhering (to GAAP principles).”
More than a third of the CFOs said that earnings which don’t correlate with cash flow from operations, or strong earnings despite falling cash flows, were significant red flags.
A 2014 study estimated that the cost to investors of a fraud at a given company was 22 percent of its enterprise value. Averaged across the market as a whole, fraud accounts for a loss equal to 3 percent of enterprise value.
If the lesson for investors is to pay attention to culture, the message to executives and boards is that they ignore the culture of their company and how it impacts employees at their peril.
“As with so many other corporate improprieties, many people at Wells Fargo knew for some time about the fraudulent sales practices,” Ben Heineman of Harvard Law School and Harvard Kennedy School of Government, a former GE general counsel, wrote on Wednesday. (here#more-85849)
“Yet a decentralized culture - with fatal indifference and passivity in the CEO, corporate control functions and, ultimately, the board - let bad behavior go on for far too long with the involvement of far too many people.”
Employees do bad things because their jobs give them incentives to, because those very same incentives very often give them the tools with which to commit fraud, and because the whole arrangement affords them the contempt to justify it and the sense that others are in on the bezzle.
It isn’t that we’ve seen this movie before; it is a sit-com of sorts, with more episodes always in production. (Editing by James Dalgleish) )
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