One of the pillars of corporate governance is whistleblowing. It enables staff members to voluntarily provide sensitive financial information about their employers in order to fight fraud, which is a serious problem in Canada. Considering that 42% of occupational fraud is reported through tips, it is also highly successful.
Whistleblowing, however, is not just a crucial organizational tool; it is also governed by the law. Whistleblowing processes are described in National Instrument 52-110, a national regulation in Canada. This rule, which has been in effect since 2004, is applicable to all Canadian corporations with stock market listings.
It provides that any employee who wants to reveal a dubious financial problem may do so anonymously and in confidence by contacting the audit committee of the board of directors.
Despite this law, our latest research indicates that the whistleblowing mechanisms are not actually established by boards of directors. Instead, the board relies on management to carry out the policies, necessitating a high level of confidence between the board of directors and their management team.
A new approach to fraud
For our study, we interviewed members of the board of directors of some of Canada’s largest public companies, along with some auditors. We asked the board members about their involvement in whistleblowing procedures to help prevent fraud.
The board members we interviewed did not believe they were in a position to establish whistleblowing procedures because they were far removed from the day-to-day operations of their corporations.
Instead, the board members highlighted the importance of trusting their management teams to establish effective whistleblowing procedures. One board member said:
“You can’t stop collusion if its taking place, but hopefully you can make sure that you have got the right tone at the top, that you got the right controls in place. You are going to prevent frauds as much as possible and it really comes down to a lot of the behaviors that are in the organization, the culture of the organization…the tone at the top is probably the most important.”
The board must be able to trust the management teams for this process to be successful, which implies that the company has a strong ethical corporate culture. Without this culture in place, whistleblowing procedures would be ineffective.
You can’t stop collusion if its taking place, but hopefully you can make sure that you have got the right tone at the top, that you got the right controls in place. You are going to prevent frauds as much as possible and it really comes down to a lot of the behaviors that are in the organization, the culture of the organization…the tone at the top is probably the most important.
Subverting past studies
Our results differ from past studies, most of which claim that the quality of board members plays an important role in fraud prevention by positively influencing the outcomes of whistleblowing procedures.
One study found that individual characteristics, such as member independence (not being involved in the operations of the company) and financial expertise, were related to positive whistleblowing outcomes. Another found that less busy board members and smaller boards led to more positive whistleblowing outcomes.
One reason for this difference could be our method of inquiry. In the past, most researchers relied on public documents and correlation analysis to establish relationships between the qualities held by members of boards of directors with whistleblowing activities.
In other words, past researchers assumed that, because the quality of the board was related to whistleblowing procedure outcomes inside a company, board members were responsible for implementing whistleblowing procedures.
Building a healthy ethical culture
Our study offers Canadians a different perspective of business management by challenging a long-standing type of corporate governance theory known as agency theory.
This theory assumes that the board of directors, which represent the interests of shareholders, should not be overly trusting of management teams because management normally looks out for its own interest. Agency theory dictates that boards should be skeptical of management practices and, in the case of fraud prevention, establish their own whistleblowing procedures for management teams to follow.
Our results suggest the contrary instead of distrusting management, corporations should promote a healthy ethical culture as a means of preventing fraud. The primary way of achieving this is with an effective code of conduct.
Having a code of conduct alone can dramatically reduce fraud in companies. According to the 2020 Report to the Nations by the Association of Certified Fraud Examiners, companies that have a code of conduct lose 50% less funds to fraud when compared to companies that don’t have a corporate code of conduct.
Codes of conduct are sets of policies and procedures that every employee adheres to. It should include all employees at all levels in the company including upper management. How upper management adheres to the company’s code of conduct is what we refer to as the “tone at the top.” This tone, in turn, dictates how healthy a company’s ethical culture is.