Scandals Linked to Better Performance

While a new academic study finds the operating performance of companies involved in a scandal is better than their matched counterparts in the following years, experts discuss HR's role in crisis management and prevention.

Wednesday, February 25, 2015
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What happens if your CEO is linked to a corporate scandal? According to a new study, stock prices will typically plummet in the short run, but over the long term, the company's operating performance actually improves.

Scandals linked to top bosses appear to be good for business. At least, that's the finding of one study that examined 80 CEO-related scandals in the US between 1993 and 2011. It covered both financial misconduct and personal scandals, such as breach of contract, bribery, conflicts of interest, fraud kickbacks, price fixing, securities fraud, extramarital affairs, harassment, and lies on resumes, to name a few.

Some of the companies studied were Apple, Hewlett Packard, IBM, JP Morgan, Yahoo and Tyco. While asked to comment, they either declined or never responded.

The study was conducted by lead researcher Surendranath Jory, a lecturer in finance with the school of business, management and economics at the University of Sussex, a public-research university in the United Kingdom. His team included three more academics: Thanh Ngo, an associate professor in the department of finance at East Carolina University, and two graduate students: Daphne Wang, in the economics and finance department at the University of Texas - Pan American; and Amrita Saha, in the economics department at the University of Sussex.

Some of the study's other findings were unexpected, he says. Here's a sampling of the results: 

  • The average loss in shareholders' wealth was $1.9 billion per scandal in the month of the announcement;
  • Scandal-prone firms are usually large companies with more insiders-such as a COO or CFO-on the board of directors;
  • The stock price performance of "scandal" companies matched the performance of control firms in the long run;
  • Damage is confined to the short-term;
  • The operating performance of the firms examined was better than other similar, unaffected firms in the years that followed that scandal; and
  • Corrective actions taken by such firms tend to benefit investors in the long run.

Jory says he believes that the "noise" of corporate misdeeds would leak days-perhaps weeks-before official company announcements were made, and that investors would calculate the financial damage well before such announcements were made public.

"But it seems that investors wait for something more tangible before reacting, [like] an announcement in the media," he says.

The traditional corporate response to scandals involves designing safeguards that protect against future abuses. He says this calms investor fears of a repeat performance and avoids further drops in the company's stock price.

Still, there's plenty HR can do, Jory says, including pushing for more independent directors on the board, auditing nonfinancial performance measures-which, he says, is just as important as auditing financial account-and performing more in-depth background checks on individuals applying for high-ranking positions. He says there's no excuse for HR to be unaware of senior-level candidates who lie on their resumes.

Meanwhile, Bhushan Sethi, an advisory principal at PwC in New York who works with many financial institutions, some which have experienced leadership scandals, says he's surprised that some of the survey's results were so favorable. In reality, not every story has a happy ending. 

He offers three HR strategies when C-suite executives become entangled in a scandal.

The first, he says, is to get ahead of the story: Communicate to employees before they read or hear about leadership's wrongdoings from other sources.

"Get on the offensive  [involving] communications, be very specific, real and authentic," he says, adding that HR needs to explain what happened, how it plans to manage the impact or loss and the action it will take to mitigate the problem.

HR must also build an internal ethics campaign around employee behavior, says Sethi, who adds that some of his clients have developed mandatory training programs in which employees role-play risky scenarios and then address alternatives, decisions and consequences. He says it's important to incorporate a company's values and ethics into scenarios that clearly define how employees are expected to behave.

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CEOs can also be involved in similar, ongoing experiences, he says. A CHRO can find a coach who recognizes the importance of ethics in corporate governance and talks straight with executives about the disastrous consequences of engaging in risky or unethical behaviors.

Sethi adds that some companies use surveillance tools to monitor and analyze the behavior of employees in lower-ranking positions.

Consider financial traders who demonstrate disproportionate returns on their investments. Are there behavioral patterns that can be analyzed and predict rogue behavior? HR may discover patterns involving the types of clients they take to dinner, websites they track, or chat rooms they visit. Ideally, he says, such tools help HR obtain a 360-degree view of that employee's activity.

"The financial damage that others [besides the CEO] can do in an organization is also very large," says Sethi. "A number of organizations have gone out of business, not because of what the CEO has done, but what someone in an important or client-facing [position] has done."

Still other problems can erupt regarding inconsistent messaging, says Amy Letke, founder and CEO of Integrity HR, an HR consulting firm in Louisville, Ky. She says HR needs to work closely with in-house communications or public relations to craft internal and external messaging that mirror each other to start building back the company's credibility.

She also suggests establishing a hotline or email box to field employee questions, squelch rumors, and possibly prevent more trouble. In a hypothetical sex scandal involving a company's CEO, one accusation could lead to much more fall out, she says, such as employees claiming sexual harassment by other senior executives.

The CHRO really needs to be "astute and aware" of all the negative possibilities, says Letke.

But as long as CEOs and other senior executives remain under tremendous pressure to hit company goals or targets, the temptation to stray will be too great for some, experts agree. Such leaders may engage in deceptive practices including manipulating reported earnings figures to satisfy investors and protect their job.

"There must be a champion of HR values on the board of directors," says Jory. "Someone who is there to emphasize morals and ethics at the highest level."

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