Are private companies more ethical than public ones?
To those in the C&E field, the notion that privately held companies could, as a group, be more ethical than publicly held ones seems implausible. After all, public companies are required by law to be transparent in ways that private ones are not – and are also required to have various compliance measures that are not mandated for the latter. Moreover, at least based on anecdotal evidence, when companies go from public to private they tend to cut back on their C&E programs.
But that might not be the whole picture. As mentioned in a post last week, research in a recently published paper – “The Value of Corporate Culture,” by Luigi Guiso, Paulo Sapienza and Luigi Zingales – found that public firms seem to have a greater difficultly in maintaining cultures of integrity than do private ones. In that earlier post we focused not on that finding but what could be described as the “headline” story of that piece: that “high levels of perceived integrity are positively correlated with good outcomes, in terms of higher productivity, profitability, better industrial relations, and higher level of attractiveness to prospective job applicants.” Today, we return to the article to consider what could be the cause(s) of the link between private ownership and ethical cultures – for which the authors offer three possible explanations.
First, they note that there could be greater integrity-related communications challenges facing a public company than a private one: “if a violation of internal norms is discovered in a public corporation, in deciding the punishment, the CEO has to send two signals: an internal one to the managers and employees that also serves as deterrent for future violations and an external one to the market that maintains transparency of internal procedures. The latter poses the risk of being (wrongly) interpreted by the market as the tip of an iceberg rather than an isolated episode, inducing the top manager to dilute the punishment and the internal message. These complications may weaken integrity norms in publicly traded companies vis-à-vis private firms.”
This is indeed an interesting possibility, and something that I’ve not heard before. But the very fact that I have not heard it mentioned previously – in more than two decades of advising companies on C&E matters, attending C&E conferences and otherwise keeping track of the field – makes me somewhat skeptical about it.
Second, the authors note: “Public ownership…changes …the trade-off between the costs and benefits of strict integrity norms… If… some assets are not considered (or underappreciated in the short term), public ownership creates a distortion in decision making…” They further argue that integrity may in fact be underappreciated in the market, so that “a CEO who allocates company resources to maximize the current stock market value of a company will tend to underinvest in integrity.”
Unlike the first explanation, this one seems virtually self-evident, given the absence of any meaningful indication (at least of which I am aware) that capital markets really give sufficient weight to integrity cultures. Fortunately, the above-noted “headline” finding of the authors’ research – linking ethical cultures with profitability and other desirable business outcomes – itself has the power to change that, at least if it becomes widely appreciated and further developed by practitioners and researchers.
Finally, they state: “public ownership comes with a separation between ownership and control and the CEOs of a public corporation are not always driven solely by shareholder value maximization, since they do not fully internalize the cost of deviating from value maximization.” This, too, seems compelling to me. It has its roots in Adam Smith’s powerful insight that “[M]anagers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . [they] watch over their own,” and is, of course, broadly consistent the notion of “moral hazard,” about which much has previously been written in this blog and elsewhere.
So, for C&E professionals what is the import of these findings?
For those who work in/with public companies I think the overriding lesson is that the board needs to be involved to a meaningful extent with the C&E program. That is because directors are generally far better able to resist the pernicious effect of short-terming thinking and “moral hazard” on a company’s integrity culture than is management. Of course, much has already been written about the need for strong board oversight of compliance. But, having the relevant data from this paper should help some directors who are under-involved with C&E see the business case for stepping up their game.
Private companies, meanwhile, should not get cocky. While good news for them in a general sense, the paper doesn’t mean the pressure is off. Indeed, the overwhelming percentage of companies punished under the Federal Sentencing Guidelines tend to be small – and therefore (I assume, though can’t be totally sure) are mostly private. Moreover, as discussed in this recent posting on the D&O Diary (which was based on the results of the Chubb 2013 Private Company Risk Survey): “‘private companies increasingly are at risk of professional and management liability from a vast range of events, including costly lawsuits, governmental fines, data theft and other criminal activities’.”’