The Unfiltered Truth Necessary for Effective Corporate Governance

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Corporate governance and “long-termism” are key buzzwords in our modern fiduciary lexicon. Between Q1 2018 and Q2 2019, governance deficiencies were responsible for the highest number of enforcement occurrences across major financial services regulators, according to research from global professional services firm Navigant. In his annual letter to CEOs, Larry Fink, chairman and CEO of BlackRock, the world’s largest money-management firm, stated that, “As wealth shifts and investing preferences change, environmental, social, and governance issues will be increasingly material to corporate valuations.” And according to the S&P Dow Jones Indices, “Governance is the sustainable metric that has been viewed by most investors as the most important variable for corporate performance.”

We know that business follows the money, and the money is now looking toward governance as a long-term indicator of return.

To effectively deliver on corporate governance, organizational leadership needs the ability to reliably access, interpret and act on information. Increasingly, this requires integrating non-financial data to allow board members a more holistic view of the firm’s overall strategy, risks and performance. However, according to a survey of corporate executives, “only 11%...report being able to make decisions using a broad range of internally generated data, beyond financial metrics…” 

Board members understand that good corporate governance is paramount and that they are accountable for it, though many are not confident they have adequate information. But, they actually have more than they realize. There is an often-underutilized information stream available to executive teams and boards – internal hotline data.

"As wealth shifts and investing preferences change, environmental, social, and governance issues will be increasingly material to corporate valuations." – Larry Fink

Information surrounding internal employee reports to whistleblower hotlines and helplines – specifically, how many there are, where they are, and who and what they are about – can provide boards with valuable insight into their organization’s culture and its compliance program. While such data is typically reviewed by the audit or compliance committee, it is often done so in a vacuum and the higher-level learnings or predictive abilities are not recognized or utilized. Board members who take the time to learn how to interpret and act on such data have an additional source of unfiltered (by management) governance information.

Internal Whistleblower Trends Are Internal Governance Trends

Board members are paying increased attention to risk management and reputation issues, especially after ongoing and very public corporate scandals – and the resulting negative impact on company performance. Boards also are attuned to public opinion, as the percentage of Americans professing to have a “great deal” or “quite a lot” of trust in large businesses sits at 23%, placing them among the nation’s least-trusted institutions, according to Gallup.

Simultaneously, we’ve seen surges in the number and sophistication of laws and regulations governing matters of corporate ethics and compliance, specifically about whistleblowing. That includes the Department of Justice’s Evaluation of Corporate Compliance Programs, the European Union’s new Whistleblower Directive, and Australia’s changes to its Corporations Act.

Despite (or perhaps because of) these trends, most board members still believe that a high number of internal hotline reports are negative on principle. Others struggle with finding the “right” number of reports. Consequently, they are motivated to minimize or suppress information generated through active internal hotline use. While we at NAVEX Global, provide industry benchmarking that is reported in many boardrooms, it is important to recognize that a benchmark is not necessarily best practice. It is only a reflection of current practice or activity.

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Recent research has provided many within the compliance community the opportunity to finally challenge the conventional wisdom and elevate the importance of increased internal reporting to the board level. At the forefront is George Washington University Professor Kyle Welch’s 2018 study, Evidence on the Use and Efficacy of Internal Whistleblowing Systems, the first academic work to examine actual internal whistleblower reports in tandem with financial performance, litigations costs, regulatory fines and adverse media.

"Firms with higher hotline usage experienced 6.9% fewer material lawsuits and 20.4% less as far as litigation costs over a three-year period."

The results, as we have written about before, are striking: firms with higher hotline usage experienced 6.9% fewer material lawsuits and 20.4% less as far as litigation costs over a three-year period relative to similar companies with lower hotline use. Those firms also received up to a 2.8% bump in their return on assets relative to their peers. Active hotlines were also shown to lower regulatory fines by up to $8 million and reduce negative news coverage by up to 46%.

Welch’s research, which relies on the world’s largest database of (anonymized) hotline records from NAVEX Global, is the clearest evidence yet of a link connecting increased hotline use, better business performance, and good governance. Businesses with more hotline reports gain visibility into brewing problems giving them a chance to take remedial action. More importantly, what Welch’s research has shown, is that receiving more reports indicates a healthier culture where employees are comfortable reporting internally and are less likely to take their concerns outside of the organization.

Unfiltered Information Is Key to Uncovering Corporate Blind Spots

Boards empowered by this information also gain an asset unavailable to them in most of the other reporting – an unfiltered view. By design, most, if not all, of the normal reporting a board receives has been highly curated by senior management. This is especially true of information regarding potential red flags.

The seminal example of this is, of course, the case of whistleblower Matthew Lee’s report of irregular accounting practices at the banking institution Lehman Brothers. Lee’s concerns were sparked by the firm’s use of an accounting practice known as “Repo 105.” While the results of the investigation his memo spurred were reported to the board, any mention of Repo 105 had been scrubbed, and the board failed to take action.

Simply put, boards often don’t know what they don’t know, and hotline reporting offers a rare, unbiased and direct window into those blind spots. With better access to hotline information, and the experience and guidance necessary to interpret the results, board members can use this data to identify key risks – and act accordingly – offering improved corporate governance.

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