The Value of Integrity
Luigi Guiso (Eief)
Paola Sapienza (Northwestern)
Luigi Zingales (Chicago)
Firms and values
•
85% of S&P 500 companies have a section in their web page
(sometimes even two) dedicated to “corporate values.”
•
The values companies proclaim range from “integrity” to
“teamwork”, from “innovation” to “respect.”, from “ “creativity” to
“dedication”
Cheap Talk?
Firms and values
•
…or an essential component of a broader strategy?
•
What role do values play in a theory of the firm?
•
With few exceptions (e.g., Kreps (1990)), economics and
finance have ignored the role culture plays in firms
•
Not so the organizational literature (e.g., O’Reilly, 1989),
but a lot of ambiguity on what “corporate culture” means
•
Even more so
performance.
which
values
(if
any)
matter
for
This paper
1. Why are corporate values good (i.e., they
create value in addition of the normal
incentive schemes)
2. If they are good, why doesn’t every firm
adopt them?
3. How do the ownership and governance
structures affect the sustainability of these
values inside the firm?.
Which values?
• Most commonly advertised values in S&P
firms web pages is innovation (mentioned by
80% of them), followed by integrity and
(70%).
• Role innovation plays in firms is well-known
and amply studied
• Role played by a culture of “integrity” is not.
• We focus on this understudied dimension.
Work plan
1. Define integrity
2. “Integrity” as a social norm to reduce moral hazard
–
At the top of an organization
–
Inside an organization
3. Because it helps reduce moral hazard, an integrity value increases firm
performance
4. Use model to explore how integrity interacts with different governance
structures. Integrity more difficult to sustain
–
in publicly traded firms, where control is more in play and managers more subject to
Wall Street’s pressure
–
in private firms that plan to go public soon (as venture-backed private firms)
5. Use survey data to check these predictions
Defining integrity
Erhard and Jensen (2007): integrity is “the quality or
state of being complete; in an unbroken condition;
sound.”
• For an individual, group, or organization integrity as:
“honoring one’s word”
•
•
In their view, adherence to integrity facilitates coordination
among employees. Example: coordinating on the time for a
meeting.
•
If all co-workers arrive on time there is no cost of being
punctual; otherwise it is costly to be on time
•
Integrity - keeping your word and if you cannot, make
sure you warn that you cannot - makes it more credible
that co-workers are on time
Why does it work?
Social Norms
•
•
Why legal norms affect behavior?
–
They create an incentive scheme: who violates a legal norm faces a
certain probability of a legal punishment (Becker, 1968).
–
Outcome should be verifiable
What about social norm?
–
They do the same, but punishment is social rather than legal.
–
Outcome only needs to be observable
•
Ex: a sexual joke acceptable in Italy, not in the States.
•
Announcing a corporate “value” is an attempt to foster
a norm within the company by increasing the social
sanction and increasing the social enforcement
Problems with Social Norms
•
Why social norms do not solve all the
problems?
1.
Limited punishment available
2.
Detection must be relatively easy
3.
–
Observability
–
Simplicity of the norm (very coarse)
Need for consistency
–
•
Lead by example
An Integrity Value
•
•
A social norm to “keep your own word” helps alleviate
moral hazard problems.
Two types of moral hazard:
1. “At the top”:
•
Top managers cannot credibly commit to reward
employees who make firm specific investments
2. Inside the organization:
•
Employees less likely to cheat inside the organization
A model of limited commitment
•
•
•
•
•
•
•
•
In each period, our firm is composed of a manager/CEO
and two workers.
CEO owns 100% of the firm’s equity and is long-lived
Workers last two periods. Young workers are
unproductive, but they learn how to work within the firm
Old workers produce. Their productivity is a function of
how much they specialize to the firm.
This knowledge is firm-specific
To become specialized a worker has to incur a (private)
cost C
With probability p: specific investment => worthless
With probability (1-p): => value of Y.
Limited commitment model: 2
•
•
•
•
•
W: extra wage a worker receives for being more productive=>
Invest if (1-p)W > C
Manager willing to pay W<= (1-p)Y
Assume that (1-p)Y > C=> socially optimal the worker makes the
investment.
If contractible => promise a wage contingent on investing which
ranges between C and (1-p)Y.
If investment and output are observable but not verifiable, as in
Grossman and Hart (1986), a simple contract cannot resolve this
problem.
Limited commitment model: 3
•
•
•
Since the effort is observable the CEO can promise a wage
contingent on effort
In each period he chooses whether to maintain the promise or not
Maintaining the promise:
–
–
pay W in each period and receive Y with probability (1-p) next period from
the current young worker who will specialize
Since world is stationary, if the CEO maintains the promise this period, she
will maintain in the future. Value of maintaining the promise is:
W  (1  p)Y
p
•
If CEO reneges he makes (1-p)Y
Limited commitment model: 4
•
Hence CEO will not breach the contract if
Y
•
W
(1  p) 2
And since a worker will invest if (1-p)W > C, CEO will
not breach if
Y
•
C
(1  p)3
C
C
Y 
(1  p)
(1  p)3 optimal
Thus if
to promise the higher
wage but not feasible due to lack of commitment
A role for integrity
•
CEO values integrity (keeping his own word)=> incurs a personal
cost K(I) if breaches his word
•
Under integrity commitment strategy feasible if
Y
•
•
C
pK ( I )

(1  p)3 (1  p) 2
Thus we have :
Result 1: Ceteris paribus, firms where integrity is upheld as a
value will be more profitable.
The role of turnover
•
Let  be the probability that founder is replaced by a new CEO
•
If Y 
•
if
Anticipating this workers make specific investment
(1  p)(1   )W  C and commitment feasible if
Y
C
new CEO will have an incentive to renege
3
(1  p)
C
pK

(1  p)3 (1   ) (1  p) 2
C
pK
C
pK


Y


(1  p)3 (1  p)2
(1  p)3 (1   ) (1  p) 2
•
if
Hence if
  0 but not otherwise. Thus:
•
Result 2: Ceteris paribus, integrity is more likely to be upheld as a
value when the probability of turnover of the current CEO is lower.
good equilibrium feasible
Summing up
•
Three implications from model of limited commitment and
integrity.
1. Firms with shared integrity values should achieve higher
performance
2. Integrity less likely to be sustained as a value when CEO
turnover higher
 publicly traded firms
 venture-backed firms less likely to be able to sustain an equilibrium where
integrity is upheld.
The ideal data
•
Measures of integrity not easy to obtain:
– Proclamations of integrity in companies web site not necessarily
truthful
– What matters is integrity as it appears in the eyes of the employees
•
•
Ideally we would like to measure how workers perceive that
top managers uphold integrity as a value
A dataset assembled by the Great Place to Work Institute
fulfils this requirement
The GPTW data
•
•
•
Collects data on employees perceptions about prevailing
values through ad-hoc surveys of a sample of employees.
Purpose of survey: identify the top 100 best companies to
work for
To be in GPTW companies must
– submit an application, have been in business for at least 7 years, have at
least 1,000 employees
•
•
•
For each company, a random sample of 400 employees across
all job levels are invited to participate
Respond anonymously, response rate 60%
GPTW integrates this with factual information gathered from
company representatives
The GPTW data
•
•
•
•
•
•
•
Use surveys over 2007-2011
Include all firms that applied to GPTWI (not only the top
100)
Final sample: 679 companies, 294 privately held, 385
public companies, 191 part of S&P 500
244 interviewed employees per company
Overall 410,000 full time employees interviewed
Supplement with data on corporate ownership, presence
of founder, venture capital financing from various sources
Performance (ROS and Tobin’s q) from Compustat
Measuring integrity
•
Main proxy: employees assessment of how true is the statements in
the employee survey:
=> “Management’s actions match its words”
•
•
•
•
Use also
=> “Management is honest and ethical in its business practices”
Answers on a scale 1 (almost always untrue) to 5 (almost always
true)
Try to capture three key dimensions of integrity
–
–
“Wholeness” characteristic emphasized by Erhard et al (2007),
Ethical dimension
Sample statistics of shared values
Variable
Mean
Median
Sd
10th p.
90th p.
Obs
Managerial Integrity
3.90
3.90
0.25
3.57
4.20
639
Managerial Ethics
4.29
4.30
0.23
3.97
4.57
639
Estimation model
•
Two type of regressions:
•
Effect of integrity on firm outcomes:
yi   xi   Fi   i
•
Effect of governance structure on integrity:
xi   gi   Fi  i
•
Various problems to achieve identification, deal with some
Halo effect
•
Values highly correlated
•
May reflect a “halo effect” pervading all the answers: arises in data
collection when there is carry-over from one judgment to another
(Thorndike, 1920)
•
Model halo effect as an error-in-variable that affects potentially all the answers
xi  xi*  hi
wi  wi*  hi
•
cov(wi* , hi )  cov(wi* , hi )  0
Two potential problems: a) errors in variable; b) unobserved heterogeneity if halo
present in variables of interest
Halo effect: consequences and solution
•
Type of bias depends on whether integrity is RHS or LHS
•
Integrity RHS: yi   x *i  Fi  i  hi  yi   xi   Fi  i  (1  )hi
•
A variable z  z *i hi such that cov( xi* , z *i )  0 used as control can
address the problem
•
Integrity LHS:
•
If cov( gi , hi )  0 a variable z  z *i hi such that cov( gi , z *i )  0 used
as control can address the problem (otherwise an instrument)
x *i   gi   Fi  i  xi   gi   Fi  i  hi
The “right” z control
•
Need a variable that is affected by the halo effect and is
uncorrelated with: true measure of integrity; governance
variables
•
GPTW has 58 statements in five groups
•
Exclude a priori variables in the groups called credibility and
fairness (too close to integrity)
•
Focus on two statements:
1.
“This is a physically safe place to work”
2.
“I can be myself around here”
Impact of values on outcomes: Tobin’s q
(1)
(2)
(3)
(4)
VARIABLES
Tobin's Q
Tobin's Q
Tobin's Q
Tobin's Q
Managerial Integrity
1.417***
2.880***
(0.422)
(0.503)
1.479***
3.070***
(0.464)
(0.536)
Managerial Ethics
Safe Place
0.761
0.674
(0.557)
(0.587)
Being Myself
Company Age
Log Employees
-2.232***
-2.358***
(0.769)
(0.786)
0.001
-0.000
0.000
-0.001
(0.002)
(0.002)
(0.002)
(0.002)
-0.087
-0.123*
-0.094
-0.131**
(0.066)
(0.066)
(0.066)
(0.066)
1 sd increase in integrity =>25% of 1sd in Tobin’s q
Impact of values on outcomes: ROS
(5)
(6)
(7)
(8)
VARIABLES
ROS
ROS
ROS
ROS
Managerial Integrity
0.041
0.174***
(0.030)
(0.036)
0.023
0.164***
(0.033)
(0.039)
Managerial Ethics
Safe Place
0.096**
0.111***
(0.040)
(0.042)
Being Myself
Company Age
Log Employees
-0.176***
-0.159***
(0.055)
(0.056)
0.000
-0.000
0.000
-0.000
(0.000)
(0.000)
(0.000)
(0.000)
-0.006
-0.009*
-0.007
-0.009*
(0.005)
(0.005)
(0.005)
(0.005)
1 sd increase in integrity =>40% of 1sd in ROS
Impact on other outcomes
(1)
VARIABLES
Managerial Integrity
(2)
-0.038
(0.024)
-0.125***
(0.033)
Log Employees
-0.046*
(0.028)
-0.195***
(0.033)
-0.204***
(0.031)
Being Myself
Company Age
(4)
Unionized Unionized Unionized Unionized
Workers/E Workers/E Workers/E Workers/E
mployees mployees mployees mployees
Managerial Ethics
Safe Place
(3)
0.000***
(0.000)
0.013***
-0.011
(0.050)
0.000***
(0.000)
0.012***
0.000***
(0.000)
0.013***
-0.171***
(0.034)
0.030
(0.049)
0.000***
(0.000)
0.012***
Impact on other outcomes -2
VARIABLES
Managerial Integrity
(9)
(10)
(11)
(12)
Top100
Top100
Top100
Top100
Universum Universum Universum Universum
Student
Student
Student
Student
Survey
Survey
Survey
Survey
0.058
(0.057)
0.216***
(0.076)
Managerial Ethics
Safe Place
0.186**
(0.073)
Being Myself
Company Age
Log Employees
0.057
(0.067)
0.183**
(0.080)
0.000
(0.000)
0.108***
(0.009)
-0.141
(0.114)
0.000
(0.000)
0.108***
(0.009)
0.000
(0.000)
0.107***
(0.009)
0.248***
(0.080)
-0.161
(0.114)
0.000
(0.000)
0.107***
(0.009)
Corporate ownership and values
(1)
(2)
(3)
(4)
(5)
(6)
Managerial
Integrity
Managerial
Integrity
Managerial
Integrity
Managerial
Ethics
Managerial
Ethics
Managerial
Ethics
-0.105***
(0.019)
-0.106***
(0.019)
0.020
(0.030)
-0.067***
(0.017)
-0.069***
(0.017)
0.024
(0.026)
0.750***
(0.049)
-0.010
(0.008)
0.000
(0.000)
-0.025
(0.022)
-0.048**
(0.019)
0.747***
(0.049)
-0.010
(0.008)
0.000
(0.000)
-0.025
(0.022)
-0.047**
(0.019)
-0.117***
(0.021)
-0.085
(0.070)
0.132*
(0.075)
0.751***
(0.051)
-0.009
(0.008)
0.000
(0.000)
-0.023
(0.022)
-0.046**
(0.020)
0.794***
(0.043)
-0.010
(0.007)
0.000*
(0.000)
-0.030
(0.019)
-0.058***
(0.017)
0.791***
(0.044)
-0.010
(0.007)
0.000*
(0.000)
-0.031
(0.019)
-0.058***
(0.017)
-0.078***
(0.019)
-0.049
(0.061)
0.094
(0.066)
0.790***
(0.045)
-0.010
(0.007)
0.000
(0.000)
-0.031
(0.020)
-0.058***
(0.017)
Number of coverages of the health insurance
-0.001
(0.012)
-0.001
(0.012)
-0.005
(0.012)
-0.003
(0.011)
-0.003
(0.011)
-0.006
(0.011)
Number of onsite percks and benefits
0.008**
(0.003)
-0.011**
(0.005)
0.060
(0.071)
0.008**
(0.003)
-0.011**
(0.005)
0.062
(0.071)
0.008**
(0.003)
-0.010**
(0.005)
0.082
(0.074)
0.006*
(0.003)
-0.001
(0.004)
0.087
(0.062)
0.005*
(0.003)
-0.001
(0.004)
0.090
(0.063)
0.006**
(0.003)
0.000
(0.004)
0.108*
(0.065)
VARIABLES
Public
=1 Company is venture backed
Public*Venture Backed
Safe Place
Log Employees
Company Age
Business-to-Consumer
Layoff
Average Tenure
Manager (Survey Average)
Controls: usual, plus share or male, blacks, Hispanics, average age and
tenure. Effect of public=> 40% of 1SD in integrity
IV Strategy
VARIABLES
Public
First Stage
Public
IV
IV
Managerial Integrity Managerial Ethics
-0.245*
(0.135)
0.016**
(0.008)
Fraction Public (NAICS3)
0.333**
(0.161)
Safe Place
0.068
0.757***
(0.119)
(0.055)
357828.04.576363.1
Log Employees
0.155***
0.013
(0.017)
(0.024)
Business-to-Consumer
-0.010
-0.022
(0.051)
(0.022)
Layoff
0.156***
-0.025
(0.044)
(0.030)
Number of coverages of the health
insurance
0.013
0.003
(0.028)
(0.013)
Number of onsite percks and benefits
-0.004
0.008**
(0.008)
(0.003)
Average Tenure
-0.023**
-0.014**
(0.010)
(0.006)
Manager (Survey Average)
0.232
0.104
(0.168)
(0.080)
-0.134
(0.114)
Highest Industry M/B
0.785***
(0.046)
0.001
(0.020)
-0.025
(0.019)
-0.049*
(0.025)
-0.001
(0.011)
0.006**
(0.003)
-0.001
(0.005)
0.114*
(0.068)
Other Corp. Governance Variables
VARIABLES
Venture Backed
Perc. Inside Directors
Managerial
Integrity
Managerial
Integrity
Managerial
Integrity
Managerial
Integrity
Managerial
Integrity
Managerial
Integrity
0.067*
0.042
0.069**
0.062*
0.062*
0.062*
(0.034)
(0.036)
(0.031)
(0.033)
(0.037)
(0.036)
0.157
(0.121)
G-Index (last available observation
in risk metrics)
0.003
357828.04.576363.1
(0.005)
Perc Inst. Investors
0.009
(0.038)
Perc. Owners more 5 perc.
-0.122**
(0.061)
CEO Log(Total compensation (K
USD))
-0.002
(0.011)
CEO Variable to Total
Compensation
-0.027
(0.070)
Safe Place
0.759***
0.691***
0.763***
0.746***
0.700***
0.702***
(0.069)
(0.074)
(0.061)
(0.069)
(0.072)
(0.072)
A case-study : the insider view at Goldman
Greg Smith accused of having a “toxic and destructive culture”.
357828.04.576363.1
Conclusions
•
85% of firms post some corporate values, with integrity at the
top
•
The values shared by the employees are positively correlated
with a company’s financial performance and quality of labor
relations
•
Being private seems to sustain stronger values
•
A simple model of commitment can account for these
correlations