An ethical corporate culture can prevent corporate fraud by helping whistleblowers

A new study has found that a healthy and ethical corporate culture plays a bigger role in fraud prevention than its board of directors. (Shutterstock)

Whistleblowing is a cornerstone of corporate governance. It allows employees to anonymously disclose questionable financial information about their company to help prevent fraud, which is an urgent problem in Canada. It’s also incredibly efficient, with 42% of business fraud reported through tips.

But whistleblowing isn’t just an essential organizational tool — it’s also codified in law. In Canada, whistleblowing procedures are defined in national regulations called National Instrument 52-110. This regulation has been in place since 2004 and applies to all publicly traded companies across Canada.

It specifies that the board of directors, through its audit committee, must establish a set of procedures guaranteeing anonymity and confidentiality to any employee who wishes to disclose a questionable financial matter.

Despite these regulations, recent research from us suggests that boards of directors, in fact, are not the ones that establish whistleblowing procedures. Instead, board members depend on management to implement procedures, which requires a high level of trust between the board and its management team.

A new approach to fraud

For our study, we interviewed board members of some of Canada’s largest public companies, as well as auditors. We asked board members about their involvement in whistleblower procedures to help prevent fraud.

The board members we interviewed did not believe they could establish whistleblowing procedures because they were so removed from the day-to-day operations of their businesses.

Instead, board members stressed the importance of trusting their management teams to establish effective whistleblowing procedures. A council member said:

“You can’t stop collusion if it happens, but hopefully you can make sure you have the right tone at the top, that you have the right controls in place. You’re going to prevent fraud as much as possible and it really comes down to a lot of the behaviors that are in the organization, the culture of the organization… the tone at the top is probably the most important.

But this process only works if the board can trust its leadership teams, which means the organization has a healthy ethical organizational culture. Without this culture in place, alert procedures would be ineffective.

Whistleblowers and the whistleblowing procedures that protect them are a crucial part of corporate fraud prevention.  (Shutterstock)

Whistleblowers and the whistleblowing procedures that protect them are a crucial part of corporate fraud prevention. (Shutterstock)

Subvert past studies

Our results differ from previous studies, most of which claim that the quality of board members plays an important role in preventing fraud by positively influencing the outcomes of whistleblower procedures.

A study found that individual characteristics, such as member independence (not being involved in company operations) and financial expertise, were linked to positive whistleblowing outcomes. Another found that less busy board members and smaller boards resulted in more positive whistleblower results.

One of the reasons for this difference could be our survey method. In the past, most researchers relied on public documents and correlation analyzes to establish relationships between qualities held by board members and whistleblower activities.

In other words, ancient scholars assumed that because board quality was related to the outcomes of whistleblowing within a company, board members were responsible for implementing the whistleblowing procedures.

Board members did not believe they could establish whistleblower procedures because they were so removed from the day-to-day operations of their companies.  (Shutterstock)

Board members did not believe they could establish whistleblower procedures because they were so removed from the day-to-day operations of their companies. (Shutterstock)

Building a healthy ethical culture

Our study offers Canadians a different perspective on corporate management by challenging a long-standing type of corporate governance theory known as agency theory.

This theory assumes that the board of directors, which represents the interests of the shareholders, should not place too much trust in the management teams because management normally looks out for its own interests. Agency theory dictates that boards should be skeptical of management practices and, in the case of fraud prevention, establish their own whistleblower procedures for management teams to follow.

Our results suggest the opposite: instead of distrusting management, companies should promote a healthy ethical culture as a way to prevent fraud. The main way to do this is to have an effective code of conduct.

Having a code of conduct on its own can significantly reduce fraud in businesses. According to the 2020 report to the Nations from the Association of Certified Fraud Examiners, companies with a code of conduct lose 50% less funds to fraud compared to companies that do not have a corporate code of conduct.

Codes of conduct are sets of policies and procedures to which every employee adheres. It should include all employees at all levels of the company, including senior management. How senior management adheres to the company’s code of conduct is what we call “tone at the top”. This tone, in turn, dictates the health of a company’s ethical culture.

This article is republished from The conversation, an independent non-profit news site dedicated to sharing ideas from academic experts. It was written by: Hanen Khemakhem, University of Quebec in Montreal (UQAM); Mahboub Zaman, University of Hull; Nadia Smaili, University of Quebec in Montreal (UQAM)and Richard Fontaine, University of Quebec in Montreal (UQAM). If you found it interesting, you might Subscribe to our weekly newsletter.

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The authors do not work for, consult, own stock, or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.

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