Interview with George Washington University Professor Kyle Welch on his Corporate Whistleblowing Research
Whistleblower Insider had the chance to interview Professor Kyle Welch, who teaches accounting at George Washington University in Washington, D.C. Professor Welch has focused his research on the effects of whistleblowers in corporate America, and has found that healthy whistleblowing systems tend to make companies more profitable, the subject of fewer lawsuits, and hit with fewer, and lower, fines. Professor Welch’s research can be found here.
Whistleblower Insider: Hi professor Welch, thanks for speaking with us today, can you please introduce yourself to our readers?
Professor Kyle Welch: I’m a Professor of Accounting at GW – call me Kyle – I teach at the business school, I’m paid to do research, and I’m allowed to research whatever I want. A major field of research I’ve gotten into is whistleblowing. One of the neat things about whistleblowing is that there’s not a lot out there and there is such rich data that the topic is an academic’s dream.
Can you give us a brief introduction on your research?
Three years ago, I was sitting in my office trying to think of cool research to do – being an academic is awesome because you can research whatever you want – and I was thinking, what would be really cool to examine, what hasn’t been looked at? I made a list and at the top of my list was looking at the consequences of humans reporting problems: whistleblowing.
I completed my undergrad and masters at BYU, my doctorate of business administration at Harvard, worked at Stanford, and worked at Standard & Poor’s. While at an internship at Brigham Young, on the wall, they had an advertisement for EthicsPoint/NAVEX Global, a system for the internal reporting of corporate complaints. I thought that dataset might be fascinating to study but was initially told that the data was too sensitive. As soon as they found a way to anonymize the data to allow for just strict analysis, after two years of vetting me, they brought me on board and gave me access to the data.
From that I found some pretty cool things: If you go out on the street, find a random person, and ask them to choose between working at two companies with the same prestige, same everything, but this one has half as many internal reports of problems. Now, there’s a difference between internal and external reports. If you ask the average person, they’d say the one with less internal reports is the better firm, but my research says that’s not the case. Unexpected results are what you’re always looking for as a researcher, because that’s what helps humanity. Firms that have more internal reports are soliciting more and are better in most metrics: they’re older, with higher profit margins, lower fines, lower material lawsuits, lower settlement amounts. They tend have these positive traits.
Where it’s not positive, one of the first things to go out the door is compliance. Compliance might be less effective and reports might be lower. If you look at public companies and how entrenched management are as to have a poison pill or golden parachute, and don’t allow for management to be basically fired. These firms are less likely to have internal reports. If you’re a board member of a firm that has some of these features and you need to evaluate the whistleblower system, you need to factor in that you might not be getting as much information from these reports as you need to. From a management perspective, this changes things, because managers look at the number of reports and they’ll say wow, our reports are very high, that’s a problem, how do we get that down – which is totally the wrong approach to this if you think about it. It’s very easy to get reports down. You just hide the phone number and you don’t tell anybody to make any reports. That’s the easiest way to get the numbers down, but that’s not what you want. You want to see a high number of reports, because that means you have more visibility into things that you wouldn’t see otherwise.
That’s what this research shows is that if you’re doing an analysis and you have a benchmark – so NAVEX Global also does benchmarking because they’re the largest providers of these systems, which is also a benefit to the study – if you can benchmark the number of reports that you have to your industry and year, and you’re above that, that is a good sign for your system because that means that you’re more likely to capture things you wouldn’t see otherwise.
Did your research focus on any specific type of company, be it industry or geographic area, or anything like that?
We focus primarily on public companies because of the ability to take public data and control for other factors. A question that comes up is, how do we know that this is causal? To any degree, causal arguments are made stronger the more you can control for other things. The classic story is, if we were to correlate shoe size to IQ, we might think that people with big feet are just brilliant. But the reality is that your feet grow as you age, so people that are older have a higher IQ because they’ve just been around longer.
When we run regressions in studies, we want to be able to control for year, industry, and firm and all those other things, so we focus our study primarily on public companies. We’re looking forward to looking at industry-specific type of things because there’s certain industries that really promote this stuff where you can see it mattering beyond financial things. You think about healthcare. You have a rogue nurse or administrator that’s not following the compliance rules. That puts people at risk that could then factor into outcomes. We’ve yet to dive into industry-specific kind of studies, and there’s definitely argument for certain industries using the systems more or less, but nothing that I can say to narrow it down beyond public companies right now.
You mentioned you worked at S&P before becoming an academic. Obviously, the financial industry is highly regulated. Were you ever in the situation where you considered being a whistleblower?
I’ve worked in situations where there have been problems in organizations in the past – that’s one of the neat things about the research. There’s this theory out there in business schools and management that if you can put the perfect team together and the perfect leader together, you’re going to get rid of problems. That is not the case. What this shows is that it’s actually the opposite. If you’re managing humans – which every organization is – if you’re managing humans, you’re just going to have problems. There’s always going to be someone doing something inappropriate to someone else in the organization. There’s always going to be problems with theft or compliance. Problems are going to persist in every organization. The neat thing about this research and about whistleblowing is that it uses humans and extracts the information from humans that you can’t get from other systems, that you can’t get from your accounting system, that you can’t get from your operation systems. Your operation system isn’t going to tell you that your employees are falling off the job line because they’re getting harassed by one of the line managers and they’re putting themselves at risk. Your other systems won’t capture this human interaction and the problems that come with that as much as an internal whistleblowing system.
There are two analogies that come to mind. When managers talk about this, they don’t really have the right mindset sometimes. They think of it kind of like what I call the cockroach theory, that if they see one problem, there must be a ton more that are festering behind the walls. I prefer to think about this as a cutting wood kind of approach, and that’s that if you cut wood, you’re going to end up with sawdust. Period. No matter how much wood you cut, you’re going to end up with sawdust. And what you need as a manager is, how can I be aware of as many things as possible? The way you do that is you promote, you market, you solicit feedback via your internal system. Some managers say, aren’t I going to get a lot of garbage? Yeah, you’re going to get a lot of reports that are frivolous.
Carrie Penman is someone who works at NAVEX Global, and she calls the reports “stray cats and donuts.” That’s because she remembers one time when she was looking at compliance reports like this, someone called the whistleblowing hotline to complain about stray cats in the parking lot. The other call that she got was, someone called to complain about not getting enough donuts on Donut Day. In the whistleblowing world, obviously, these aren’t huge crises. You’re going to get reports like that, but that’s not the reason that you use the system. You use the system to make sure you capture the other reports.
This conversation is a good lead-in to my next question. Let’s say, hypothetically, tomorrow you become the CEO of a Fortune 500 company. What would you change from what you’ve seen in the corporate culture through your research?
Probably the better way to frame the question is, if I’m a CEO because of the way I’m built, I would totally use these systems and exploit these systems to get as much information as possible. I would actively market it, actively solicit it. I would have meetings for it brought up. On a quarterly basis, this would come up as like, Rick, give us the feedback. The second way to iterate that question is, if I’m in charge of monitoring the CEO and monitoring the organization, if I’m a board member –
Sure, let’s say you’re the chairman of the board, but the previous question.
This changes everything. As part of the audit committee in a board, you have to review these systems. If I’m the chairman, I would absolutely make this a core focus. However frequently we’d meet, it would be one of the first topics of the meeting. When you think about it, every report the board gets is filtered by the CEO. Lehman Brothers is a fantastic example. Lehman Brothers had a whistleblower, internally, that said they were making manipulative statements on their Repo 105. This was well known and well documented that they had an internal whistleblower. And that whistleblower created a report in their system. I’m sure they looked at whistleblower reports and say hey, have the auditor examine it. Well the auditor works for the firm but guess who they also work for? The CEO, right? They looked into it and they never followed up on it. They had that problem identified to them and they still missed out on it because it wasn’t, I think, a core focus. This is the bigger layer. You put on the fact that the CEO at Lehman Brothers, they did an analysis of their portfolios, these asset-backed securities. They did an analysis of it because they were deep into it, they were one of the first ones to just totally fold with it, and one of the analysis showed that if the market tanked, like it did in 2008, that they would be going bankrupt, and they’d be put in a really bad way as a business.
That was one of the iterations of their models that they did in the presentation that they were going to give to their board. But guess what? The executives at Lehman Brothers decided to filter that out of the actual presentation to the board. So what you have is, as a board member, you can only see what’s in front of you. And one of the neat things about these whistleblowing systems is it gives you a sense of things, it’s a direct path, to get a sense of what’s going on in the organization, particularly problems in this organization, in a way that is unfiltered. And that, if you are monitoring something, is without question, super important.
That makes a lot of sense and that’s an angle that I don’t think we’ve considered. What advice would you give to policymakers, be it Congress or the executive branch, on how to best utilize your research and what kind of laws they can pass to empower whistleblowers to fight fraud?
It’s clear that whistleblowing and using employees to get feedback is a critical resource. The biggest problem is anything that would, one, get in the way of a whistleblower coming forward and fixing the problem, and usually that is caused by fears of retaliation. I don’t know if you’ve looked at what’s gone on with the VA, and the whistleblowers, and their complaints that they were retaliated against?
Yeah, we’re very familiar with the retaliation some whistleblowers face.
So retaliation is one of the first things. If you talk to anyone that manages these systems on a professional level that knows what they’re doing, they know that whenever you get a scent of retaliation, it kills the system. It just kills it. You’re not going to report on somebody if you feel like just giving a question or a report is going to cause blowback to you. The average person that works at an organization wants the organization to fix the problem. Most people will want to go to their managers and the firm and say, this is wrong, we should fix it. But if the firm gives the sense that their job is on the line or that they’ll be canned if they’re wrong about it? You might just have a hunch about it, it could be completely wrong. Well if you have a problem and your hunch turns out wrong and you can’t report on it, that creates a disincentive to report.
The other disincentive that’s created in reporting is, in Europe right now, certain countries make it so if you were going to report someone, the person you report gets to know who reported them. Now, this seems like some sort of philosophical, constitutional argument that you can’t sully someone’s reputation just by submitting a report. It turns out when you do that type of thing, if you have a hunch that something’s not right – you might not have a ton of proof, something just doesn’t seem right – that’s how a lot of things start. Not everybody has 100% proof of a problem, but they might have enough to say hey, this should be examined. If it’s wrong, so be it, but if it’s right, we want to know.
If you look at the world of accounting – I come from a background of training people in accounting – one of the biggest problems with accounting is that fraud can be hidden for a period of time. One salient example of this is all the money laundering that’s going on, with these oligarchs shoveling money through a bank in Europe. One of the biggest problems about money laundering is that no one in the process is incentivized to blow the whistle. The bank isn’t, because they’re getting great fees and making tons of money for laundering money. The person that’s submitting the money obviously wants their money cleaned, so they like it. The regulators, the people that actually tax the bank, the bank doesn’t come up as a red flag because you’re getting more tax revenue from it. So everyone in the process is not really incentivized to blow the whistle and it’s one of the biggest problems. As a result, the way you end up finding a lot of these problems, be it tax problems, be it money laundering, all these problems end up being hard to identify from anything other than a human saying, this looks wrong, this should be looked at.
What do you think about regulators incentivizing whistleblowers? Have you done research on those programs?
It’s a mixed bag. It depends. The SEC seems to have the understanding that these things are best solved by firms internally first, and quickest solved by firms internally first. The SEC claims to make awards to individuals based on them reporting things internally in organizations first and the firm being unresponsive. Everything that I can observe from where I’m at, they seem to appreciate the internal process for fixing the problems and it being one of the better ways to solve a problem. That said, if you can make $500,000 by going external and staying external, or $2 million by going external at the same time you go internal and maybe they solve the problem internally, you have a strong financial incentive to go external, right? If you put a payout at risk as a result of going internally first, that creates a bit of a perverse incentive for whistleblowers.
It’s without question, something that has to be considered and evaluated. This research that’s coming out now, with this data, is the tip of the iceberg of what we’ll be able to look at and see and study. Unfortunately, I don’t have any conclusive things on it. What I can say is that we do observe a downtick in the number of financial reports, accounting issues, that get reported on internal systems shortly after Dodd-Frank gets implemented.
Where do you see your research going? Do you see yourself doing more research on this topic or other whistleblower topics?
For academics, this is what you wait for you in a career: a dataset that is unique, insightful, and has an impact on humanity in a different kind of way. Of course, every academic loves what they’re doing but this is really neat. I see this as impacting firms, but if you think about it, there’s a lot of things that don’t have financial consequences that this impacts. I’ve been in bad work environment in my past, and an employee takes that home with them. When they’re working in a bad work environment that maybe the CEO or boss or manager doesn’t know about, they take that home to their wife and their kids and it impacts other aspects of their life. There’s a lot of things that we can’t observe and can’t measure with 1’s or 0’s or dollars that these systems impact, and they’re super important for us. I’m going to be working on this topic related to whistleblowing probably for the next 10, 15 years and iterating over these different things with this dataset.
Do you have any specific projects in mind that are coming next?
What economists are obsessed with is identification – meaning, being able to use random assignments or quasi experiments to determine causality. The nice thing about the regulation and the nice thing about NAVEX Global being a global firm is that there’s a lot of regulation in different countries for different reasons, and you can imagine that cultures are different.
Supposedly in Europe, though the EU has pushed a positive note toward whistleblowing, they have some residual, cultural concerns about whistleblowing. This is something the old German government used to use for tattle-taling on people that weren’t part of the Nazi party and they associate it with that. Just because Hitler also used guns, that doesn’t mean the military shouldn’t use guns. This is something that’s useful for any organization that deals with people for finding problems. The problems might be that people are not nice or there’s other things to root out.
Culturally in the EU, they have not progressed to where the United States is, where we celebrate whistleblowers in a different way, even though we still have some residual problems. If you think about it, whistleblowers in certain situations are referred to as snitches or rats. Whenever somebody asks a question about, well, are they tattle-taling
The example I always give is the Tuskegee experiment. The Tuskegee experiment happened in the 1960’s. This is where our government decided that they were going to pretend to provide medical care to people in the African American communities in the south. The people conducting the experiment found people that had syphilis and did not tell them that they had syphilis. Instead, they just observed them until their deaths. This was well into us discovering that penicillin is a cure to syphilis. Our government funded this. Somebody within the organization heard about it in 1966 and said “hey, you got to stop this.” The whistleblower reported what he found to in a letter to his adviser. He signed the letter, he said this is a bad idea and needs to be ended. The researchers ignored him.
Then in 1968, he blew the whistle again. In 1968, there were race riots and protests going on, so he changed the tone of his complaint and he said it would look bad because of the current political environment. The government instituted a blue-ribbon panel to review it. Even with that blue-ribbon panel, the panelists said “let’s let this study play out.” They just basically wanted to see what the results were of people having syphilis, dying from syphilis, and how long people survive with the disease. It wasn’t until 1972, when the whistleblower went to a reporter that the conduct ceased. He reported internally in his own system twice and was ignored.
The whistleblower’s name was Peter Buxtun and I don’t know of any human that would look at that guy and say he’s a rat. Absolutely not a rat. That guy’s a hero. He tried everything to stop it. Culturally, we need to understand that these people that do this, there shouldn’t be a stigma with this. There shouldn’t be a negative connotation with this. These people that do this, they’re brave, they’re doing something important, and they uncover important things.
We’re looking forward to your future papers and the Tuskegee experiment is a powerful example of how whistleblowing can prevent immense harm in the world. Is there anything else you think you want to tell our readers?
If you’re interested in reading my paper, you can Google me, Kyle Welch, at SSRN, and the paper on whistleblowing will come right up. You can look at the study yourself, see the tests and analyses. It’s pretty impressive what happens once you start initiating a whistleblowing system
When you go from first to second decile of use of the system, you have drastic savings in fines, and in lawsuits, and in settlements of lawsuits. It’s really pretty incredible. Based on just the fines alone, it goes down north of $5-6 million going from first to second decile of use of the system, controlling for year and industry. If you think about it, these systems don’t cost millions, and so there’s a clear value add to implementing them.
People might hear this and say “the average academic is pretty skeptical on things, this guy seems pretty convinced on this stuff.” I’ll tell you, when I entered this project, I was a little nervous because I had the intuition, like I said, that the opposite of my finding was true. I thought, more firms, more reporting, equals more problems.
If you want to read the research, it’s all from me and a colleague of mine, Steve Stubben, who’s a professor at the University of Utah, and you can find our research online at SSRN.