Jaron Wilde
December 16, 2016
Gretchen Morgenson

For those who doubt that whistle-blowers are a force for good in corporate America — and yes, such skeptics exist — a new study out of the University of Iowa could not be more important. It demonstrates for the first time that financial shenanigans at companies decrease markedly in the years after truth tellers come forward with information about wrongdoing inside their operations.

Federal and state whistle-blower programs that award bounties to individuals providing tips about corporate fraud have grown in recent years. They are increasingly seen as a way to help understaffed regulators enhance their oversight of sprawling and complex corporations.

But the costs to whistle-blowers are high; they often face retaliation from their employers and are unable to find work because they are blackballed in their industry. These very real perils underscore the significance of the new research by Jaron H. Wilde, an assistant professor of accounting at the University of Iowa’s Tippie College of Business; he found a sharp and lasting drop in financial wrongdoing at companies that were subject to whistle-blower investigations.

The incidence of such tips appears to be rocketing. The whistle-blower program at the Securities and Exchange Commission, for example, heard from 4,218 tipsters in fiscal 2016, up 40 percent from the number who came forward in 2012.

The S.E.C. has awarded $136 million to 37 whistle-blowers since its program’s inception in 2011; it says that enforcement actions arising out of these tips have resulted in almost $900 million in financial remedies, much of which went to wronged investors.

But whistle-blowers’ impact on corporate practices has been less clear. While academic research on these truth tellers helped to identify past misconduct at companies, it had not done much to determine whether these courageous acts had a deterrent effect at companies.

So Mr. Wilde set out to explore acts of whistle-blowing at a large sample of companies to see if they resulted in meaningful improvements in behavior there.

“It occurred to me: What happens after a firm is the target of a whistle-blower allegation?” Mr. Wilde recalled in an interview. “Do they become less aggressive in terms of their financial reporting and tax aggressiveness? It’s an area I find to be both important from a policy perspective but also interesting in its own right.”

The data Mr. Wilde analyzed came from open records requests submitted to the Occupational Safety and Health Administration, a unit of the Department of Labor that is responsible for adjudicating employee retaliation cases under the Sarbanes-Oxley law. Enacted in 2002, that law was a response to the stunning accounting frauds at Enron, WorldCom and other companies, and it gave new protections to employees providing evidence of fraud at a company by assigning criminal penalties for retaliation against them. Employees filing retaliation claims submit them to OSHA.

The employee retaliation cases studied by Mr. Wilde spanned 2003 through 2010; he analyzed matters involving some 317 public companies in the United States.

Armed with the data, Mr. Wilde examined changes in each company’s financial reporting from a period before the alleged improprieties to afterward. Then he compared the results with corresponding changes among matching, so-called control firms.

“Following the allegations,” the study concluded, “whistle-blower firms are significantly more likely to experience a decrease in the incidence of accounting irregularities and a decrease in tax aggressiveness, compared with control firms.”

Moreover, Mr. Wilde found that the decrease lasted for at least two years, reflecting the period for which he had data on all the companies. He said he had not examined whether the behavior change wears off after the two years but said that would be an interesting analysis to make.

In addition to demonstrating the deterrent value of whistle-blowing, Mr. Wilde’s study, which will be published in a forthcoming issue of The Accounting Review, counters previous research that criticized truth tellers. Some studies have questioned whistle-blowers’ motivations in bringing cases, as well as the merits of their complaints, Mr. Wilde noted. For example, some researchers have contended that allegations of wrongdoing may be frivolous or driven by employees’ personal vendettas.

But Mr. Wilde’s research found that many of the tips were valuable. He determined that they typically involved companies with a significantly higher likelihood of financial misreporting in the period before the individuals came forward. While he acknowledged that some of the cases he studied were inconsequential, he added that there were “certainly a number of instances where whistle-blowers are providing critical incremental information that allows the government to have a case against a company or an employee.”

The study also underscores the notion that insiders are best positioned to monitor companies’ financial reporting. This has become especially true as corporations have grown larger and more complex, Mr. Wilde said.

“The organizational complexity of companies is now so high that it makes it difficult for external parties to detect misconduct,” he said. “These individuals coming forward are what allow the government to have a case in many instances.”

Mr. Wilde acknowledged in the study that his findings might be somewhat skewed because of his inability to determine whether the control companies in his study were actually free of financial irregularities. “Some control firms may actually be targets of whistle-blowing that I cannot observe,” he wrote.

In addition, he noted that his study sample was limited to cases in which employees contended they had been punished for coming forward; researching other whistle-blowing cases could generate different results. Finally, he said that his research covered the period before the S.E.C.’s whistle-blower program was in place.

Still, Mr. Wilde’s research confirms the crucial roles whistle-blowers play not only as powerful monitors in corporate settings but also as agents of change within these companies.

“If you’re a regulator, even if you know a company is doing something wrong, where do you look?” Mr. Wilde said. “The whistle-blower can pinpoint what’s going on and often can bring documentation.” If not for whistle-blowers, he said, “this stuff often goes undetected.”