The Value of Integrity

1
The Value of Integrity

• Luigi Guiso (Eief)Paola Sapienza
  (Northwestern)Luigi Zingales (Chicago)

2
Firms and values

• 85 of SP 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

3
Cheap Talk?
4
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.,
  OReilly, 1989), but a lot of ambiguity on what
  corporate culture means
• Even more so which values (if any) matter for
  performance.

5
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 doesnt every firm adopt
   them?
3. How do the ownership and governance structures
   affect the sustainability of these values inside
   the firm?.

6
Which values?

• Most commonly advertised values in SP 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.

7
Work plan

• Define integrity
• Integrity as a social norm to reduce moral
  hazard
• At the top of an organization
• Inside an organization
• Because it helps reduce moral hazard, an
  integrity value increases firm performance
• 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
  Streets pressure
• in private firms that plan to go public soon (as
  venture-backed private firms)
• Use survey data to check these predictions

8
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 ones 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?

9
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

10
Problems with Social Norms

• Why social norms do not solve all the problems?
• Limited punishment available
• Detection must be relatively easy
• Observability
• Simplicity of the norm (very coarse)
• Need for consistency
• Lead by example

11
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

12
A model of limited commitment

• In each period, our firm is composed of a
  manager/CEO and two workers.
• CEO owns 100 of the firms 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 gt
  worthless
• With probability (1-p) gt value of Y.

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Limited commitment model 2

• W extra wage a worker receives for being more
  productivegt Invest if (1-p)W gt C
• Manager willing to pay Wlt (1-p)Y
• Assume that (1-p)Y gt Cgt socially optimal the
  worker makes the investment.
• If contractible gt 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.

14
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
• If CEO reneges he makes (1-p)Y

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Limited commitment model 4

• Hence CEO will not breach the contract if
• And since a worker will invest if (1-p)W gt C,
  CEO will not breach if
• Thus if optimal to
  promise the higher wage but not feasible due to
  lack of commitment

16
A role for integrity

• CEO values integrity (keeping his own word)gt
  incurs a personal cost K(I) if breaches his word
• Under integrity commitment strategy feasible if
• Thus we have
• Result 1 Ceteris paribus, firms where integrity
  is upheld as a value will be more profitable.

17
The role of turnover

• Let be the probability that founder is
  replaced by a new CEO
• If new CEO will have an
  incentive to renege
• Anticipating this workers make specific
  investment
• if and
  commitment feasible if
• Hence if
  good equilibrium feasible
• if 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.

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Summing up

• Three implications from model of limited
  commitment and integrity.
• Firms with shared integrity values should achieve
  higher performance
• 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.

19
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

20
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

21
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 SP 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 Tobins q) from Compustat

22
Measuring integrity

• Main proxy employees assessment of how true is
  the statements in the employee survey
• gt Managements actions match its words
• Use also
• gt 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

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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

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Estimation model

• Two type of regressions
• Effect of integrity on firm outcomes
• Effect of governance structure on integrity
• Various problems to achieve identification, deal
  with some

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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
• Two potential problems a) errors in variable b)
  unobserved heterogeneity if halo present in
  variables of interest

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Halo effect consequences and solution

• Type of bias depends on whether integrity is RHS
  or LHS
• Integrity RHS
• A variable
  used as control can address the problem
  
• Integrity LHS
• If a variable
  used
  as control can address the problem (otherwise an
  instrument)

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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
• This is a physically safe place to work
• I can be myself around here

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Impact of values on outcomes Tobins 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)
Managerial Ethics 1.479 3.070
(0.464) (0.536)
Safe Place 0.761 0.674
(0.557) (0.587)
Being Myself -2.232 -2.358
(0.769) (0.786)
Company Age 0.001 -0.000 0.000 -0.001
(0.002) (0.002) (0.002) (0.002)
Log Employees -0.087 -0.123 -0.094 -0.131
(0.066) (0.066) (0.066) (0.066)
1 sd increase in integrity gt25 of 1sd in
Tobins q
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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)
Managerial Ethics 0.023 0.164
(0.033) (0.039)
Safe Place 0.096 0.111
(0.040) (0.042)
Being Myself -0.176 -0.159
(0.055) (0.056)
Company Age 0.000 -0.000 0.000 -0.000
(0.000) (0.000) (0.000) (0.000)
Log Employees -0.006 -0.009 -0.007 -0.009
(0.005) (0.005) (0.005) (0.005)
1 sd increase in integrity gt40 of 1sd in ROS
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Impact on other outcomes

  (1) (2) (3) (4)
VARIABLES Unionized Workers/Employees Unionized Workers/Employees Unionized Workers/Employees Unionized Workers/Employees
         
Managerial Integrity -0.038 -0.125
(0.024) (0.033)
Managerial Ethics -0.046 -0.171
(0.028) (0.034)
Safe Place -0.204 -0.195
(0.031) (0.033)
Being Myself -0.011 0.030
(0.050) (0.049)
Company Age 0.000 0.000 0.000 0.000
(0.000) (0.000) (0.000) (0.000)
Log Employees 0.013 0.012 0.013 0.012
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Impact on other outcomes -2
  (9) (10) (11) (12)
VARIABLES Top100 Universum Student Survey Top100 Universum Student Survey Top100 Universum Student Survey Top100 Universum Student Survey
         
Managerial Integrity 0.058 0.216
(0.057) (0.076)
Managerial Ethics 0.057 0.248
(0.067) (0.080)
Safe Place 0.186 0.183
(0.073) (0.080)
Being Myself -0.141 -0.161
(0.114) (0.114)
Company Age 0.000 0.000 0.000 0.000
(0.000) (0.000) (0.000) (0.000)
Log Employees 0.108 0.108 0.107 0.107
(0.009) (0.009) (0.009) (0.009)
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Corporate ownership and values

  (1) (2) (3) (4) (5) (6)
VARIABLES Managerial Integrity Managerial Integrity Managerial Integrity Managerial Ethics Managerial Ethics Managerial Ethics
             
Public -0.105 -0.106 -0.117 -0.067 -0.069 -0.078
(0.019) (0.019) (0.021) (0.017) (0.017) (0.019)
1 Company is venture backed 0.020 -0.085 0.024 -0.049
(0.030) (0.070) (0.026) (0.061)
PublicVenture Backed 0.132 0.094
(0.075) (0.066)
Safe Place 0.750 0.747 0.751 0.794 0.791 0.790
(0.049) (0.049) (0.051) (0.043) (0.044) (0.045)
Log Employees -0.010 -0.010 -0.009 -0.010 -0.010 -0.010
(0.008) (0.008) (0.008) (0.007) (0.007) (0.007)
Company Age 0.000 0.000 0.000 0.000 0.000 0.000
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Business-to-Consumer -0.025 -0.025 -0.023 -0.030 -0.031 -0.031
(0.022) (0.022) (0.022) (0.019) (0.019) (0.020)
Layoff -0.048 -0.047 -0.046 -0.058 -0.058 -0.058
(0.019) (0.019) (0.020) (0.017) (0.017) (0.017)
Number of coverages of the health insurance -0.001 -0.001 -0.005 -0.003 -0.003 -0.006
(0.012) (0.012) (0.012) (0.011) (0.011) (0.011)
Number of onsite percks and benefits 0.008 0.008 0.008 0.006 0.005 0.006
(0.003) (0.003) (0.003) (0.003) (0.003) (0.003)
Average Tenure -0.011 -0.011 -0.010 -0.001 -0.001 0.000
(0.005) (0.005) (0.005) (0.004) (0.004) (0.004)
Manager (Survey Average) 0.060 0.062 0.082 0.087 0.090 0.108
(0.071) (0.071) (0.074) (0.062) (0.063) (0.065)
Controls usual, plus share or male, blacks,
Hispanics, average age and tenure. Effect of
publicgt 40 of 1SD in integrity
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IV Strategy

  First Stage IV IV
VARIABLES Public Managerial Integrity Managerial Ethics
       
Public -0.245 -0.134
(0.135) (0.114)
Highest Industry M/B 0.016
(0.008)
Fraction Public (NAICS3) 0.333
(0.161)
Safe Place 0.068 0.757 0.785
(0.119) (0.055) (0.046)
Log Employees 0.155 0.013 0.001
(0.017) (0.024) (0.020)
Business-to-Consumer -0.010 -0.022 -0.025
(0.051) (0.022) (0.019)
Layoff 0.156 -0.025 -0.049
(0.044) (0.030) (0.025)
Number of coverages of the health insurance 0.013 0.003 -0.001
(0.028) (0.013) (0.011)
Number of onsite percks and benefits -0.004 0.008 0.006
(0.008) (0.003) (0.003)
Average Tenure -0.023 -0.014 -0.001
(0.010) (0.006) (0.005)
Manager (Survey Average) 0.232 0.104 0.114
(0.168) (0.080) (0.068)

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Other Corp. Governance Variables

VARIABLES Managerial Integrity Managerial Integrity Managerial Integrity Managerial Integrity Managerial Integrity Managerial Integrity
             
Venture Backed 0.067 0.042 0.069 0.062 0.062 0.062
(0.034) (0.036) (0.031) (0.033) (0.037) (0.036)
Perc. Inside Directors 0.157
(0.121)
G-Index (last available observation in risk metrics) 0.003
(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)

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A case-study the insider view at Goldman Greg
Smith accused of having a toxic and destructive
culture.

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• 357828.04.576363.1

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Conclusions

• 85 of firms post some corporate values, with
  integrity at the top
• The values shared by the employees are positively
  correlated with a companys financial performance
  and quality of labor relations
• Being private seems to sustain stronger values
• A simple model of commitment can account for
  these correlations