In this podcast series, I interviewed Dr. Kyle Welch, Assistant Professor at George Washington University (GWU), on his recently released paper, co-authored with Stephen Stubben, Associate Professor from The University of Utah, entitled “Evidence on the Use and Efficacy of Internal Whistleblowing Systems” (Report). In this paper, Welch and Stubben reviewed some 15 years of anonymized data from NAVEX Global, Inc., the sponsor of this podcast series. This data was from the company’s hotline reporting systems. Some of the key findings included that companies with a robust whistleblower and reporting system had greater profitability and workforce productivity as measured by Return on Assets (ROA) and there were fewer material lawsuits brought against the company overall and there were lower settlement costs if a lawsuit did occur. Finally, there were fewer external whistleblower reports to regulatory agencies and other authorities. Throughout this series we are taking a deep dive into the Report. Today we find out the impact of whistleblower reporting systems on power users and expand the definition of litigation.

While acknowledging he was “open to any finding”; one of the things Dr. Welch expected was a finding that a company with more whistleblower complaints would follow that the company would have more problems and certainly high litigations and regulatory costs. He stated, “if you were to take a job at one firm and all other things being equal, if one entity has more reports internally, it would have problems.” He even analogized it to “Ockham’s Razor, that the simplest answer is that maybe that entity just has more problems.” However, what Dr. Welch found was that if there were a larger number of internal reports, it allowed a compliance officer or other to go to any area where there were clusters of reports due to this greater visibility.

However, it led to an initial finding that companies with a more robust internal reporting system generated more reports. Dr. Welch noted, “what we did is we looked at a large segment of data, lots of data on internal reports, from a long tail of history.” They reviewed data from over a million reports related to public companies and had access to over 3 million other reports. All the data was anonymous, not disclosing individual details, which enabled them “to do the study and actually connect with good external data.”

He then turned a group of companies he termed “power users”, which were high level users of whistleblower reporting systems who had more activity than the average entity. He stated, “We,  used a couple of measures of this reporting. We looked at level of reports, including how many reports they have and then a combined measure of how engaged they were with the reports. For instance, how quickly did it take for a company to resolve the issue and then how many times the whistleblower report was accessed?”

These “power user’ companies have several interesting characteristics. Dr. Welch related “what we found is that those that are more engaged with these systems are typically firms with a higher quality earnings reporting. They are usually larger firms. They are more mature and they are more profitable firms.” These entities were also seen to have higher ROA. Finally, these “power user” companies were firms with higher quality governance, as rated by the Entrenchment Index(Index), which is used measure how entrenched management is in a company. “Those with higher governance in their organization are the power users, the ones that use it and have more reports and are more engaged with the system.”

Conversely, companies which were observed to be a more limited user of whistleblower reporting systems were companies that were seen to have poor governance. They were also more prone to financial accounting issues, such as discretionary accruals, which could prove problematic. They were also smaller and less mature firms. Their overall compliance programs were generally not seen as robust or as effective as those in larger, more mature organizations. Finally, these firms, probably because they were smaller and less mature, were more prone to extreme growth and the problems associated with trying to scale up quickly.

One point which was extremely important was Dr. Welch’s use of the term “litigation”. As a recovering trial lawyer I explained to him that I interpreted the term to mean civil litigation between private parties. However, when I raised this, Dr. Welch indicated that his intended interpretation was broader than simply civil litigation between parties. He intended it to include regulatory and enforcement action, basically anytime anyone went to court, which would certainly include Foreign Corrupt Practices Act (FCPA) settlements where a Deferred Prosecution Agreement (DPA) was agreed to or a criminal conviction secured.

When you expand his finding that the cost of litigation to the cost of all regulatory enforcement and litigation was reduced by a material amount, you begin to see the power in the findings around whistleblower reporting systems.

In the next episode, we consider some of the specific findings made in the Report.

This series is sponsored by NAVEX Global, Inc.

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