Effects of Anonymous Whistle-Blowing and Perceived Reputation Threats on Investigations of Whistle-Blowing Allegations by Audit Committee Members
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James E. Hunton (Bentley College) and Jacob M. Rose (University of New Hampshire)
Journal of Management Studies, forthcoming
February 2010 (online version)
The landmark Sarbanes-Oxley Act of 2002 mandated that audit committees of publicly traded firms must give whistle-blowers a way to anonymously disclose possible financial fraud without fear of prosecution. But the authors of this paper have uncovered disturbing unintended consequences of the regulation that may be rendering it ineffective. Namely, audit committee members appear to be less likely to take action on anonymous tips than on non-anonymous complaints and, in some cases, they are motivated to ignore anonymous whistle-blowers because if their claims prove out it could indicate that the committee failed to oversee the company’s activities satisfactorily.
The researchers conducted experiments with 83 highly experienced audit committee members who served on the boards of medium or large U.S. companies and who were responsible for evaluating whistle-blowing allegations. After receiving a hypothetical complaint (either anonymously or non-anonymously) that involved potentially fraudulent financial reporting, the participants were asked to determine the credibility of the charge and allocate resources to investigate it. The directors who received the anonymous complaint were significantly less likely to look into it deeply. Even when they chose to investigate, the amount they were willing to spend was far less than the amount determined by the directors who read the non-anonymous complaint, an average of about US$24,000 versus $40,000. This result mirrors a study from the National Bureau of Economic Research that found the instances of fraud detected by whistle-blowing actually fell from 21 percent to 16 percent after Sarbanes-Oxley set up the anonymous channels.
The authors note that it can be harder for audit committee members to investigate anonymous reports since the complaint may lack detailed information and the unknown source cannot be questioned. But the potential conflict of interest cannot be ignored: Audit committee members that energetically investigate the whistle-blower’s claims could be putting their own jobs at risk, particularly if, for example, a substantial revenue and profit restatement is the outcome. Given the recent spate of accounting and finance scandals in the United States, the authors argue that anonymous whistle-blowing channels should be reformed further to guard against such conflicts of interest in evaluating allegations. One potential solution is to require an independent third party, such as lawyers or external auditors not affiliated with the company, to receive all whistle-blowing reports, assess the validity of each complaint, and then forward the allegation to the audit committee with a summary analysis of its merits.
The channels that exist for anonymous whistle-blowing allegations of financial fraud are inadequate and dysfunctional. Audit committee members charged with assessing the validity of the claims are less likely to fully investigate anonymous reports, especially if such reports could harm them.