Thief, Liar, Cheater! Do bad guys really finish last?

by Jenna Moore

In late 2012 Lance Armstrong ceased denying doping rumours. The seven-time Tour de France winner went from hero to zero faster than the news could be put to print around the world. Though some had always been dubious about his seemingly superhuman performance, there is no doubt Oprah’s extra long (and extra lucrative) expose would have left many die-hard Armstrong fans lost and troubled by the relentless and self-righteous deceit spanning more than a decade. Armstrong cemented himself as a cycling legend; a cancer survivor; a philanthropist, and he sure knew how to sell the sizzle without the steak. Lance Armstrong’s business was Lance Armstrong. His reputation was his capital and not only has he forfeit a large part of his future reputational nest-egg, he stands to be disrobed of the ‘unjust’ riches he was awarded by the US Federal Government through sponsorship deals amounting to US$40m. But even still, despite the seemingly rigorous international anti-doping measures in place, Armstrong proved the reward was worth the risk and is estimated to have accumulated a net worth of over $125m. Do bad guys really finish last?

As humans we seek ambitiously to create order and go to great lengths to level the playing field when it comes to individuals and businesses alike. Millions of dollars are spent each year monitoring corporations, and funding investigations into corporate misconduct in an effort to protect consumers, employees, the environment and society at large. But, is it effective? Are the deterrents working? Did the Sarbanes-Oxley Act really change the propensity for managers to ‘cook the books’? What are the costs of ethical corner cutting, and who is footing the bill?

Between 1996 and 2009, 3059 cases were filed against public companies in U.S. federal courts and despite approximately two thirds being dismissed, it does lead one to infer that a substantial number of firms are living dangerously close to the ethical edge. This trend continues today. In the last four months, since the West welcomed the New Year 2013, some form of corporate misconduct or financial fraud has reached the headlines every week. Thankfully for news readers the perpetrators like to keep it interesting, with cases including: failure to report correct financial information (x 22!); a $1B lawsuit for faulty accelerators; foreclosures auction rigging; fraudulent patents used to rip off the national US health system; exploitation of foreign workers; insider trading; money laundering; etc … (not to mention some of the numerous environmental breaches!). And all of this is going on despite corporate credibility being the defining issue of today?

The intrigue is the persistence of what I will call ‘corporate doping’. Based on the notion that business is a series of contractual arrangements between various parties, of who can take advantageous positions levered on their good reputation, how much weight if any are decision makers allocating to reputational capital when deciding on a modus operandi?

In 2004, the cost of reputational capital losses attributed to unscrupulous behaviour was estimated to equal the earnings of the top 40 US companies. But who is losing out? In 2010 Tibbs, Murphy and Shrieves found that corporate misconduct is of net benefit to shareholders and claimed, “based on stock and operating performance there appears to be a benefit to firms committing third-party crimes”. So if crime does pay, where is Enron? This result is counterintuitive and is in contradiction to the work of Karpoff (2012), which highlighted surprisingly large (although unarticulated) reputational penalties for corporate deviancy. But controversially both findings are mutually compatible. The difference is in the terms of trade. If a business is involved in wrongdoing which negatively affects parties that impact cashflows, they will be heavily penalised both through direct loss of short-term costs (litigation, fines, remediation, etc.) and also through loss of reputational capital, a more systemic cross to bear. Anecdotal evidence suggests we imagine our choice to continue our custom and our word of mouth marketing is powerful enough to have a lasting impact on a business, thus compelling the business to deliver on its promises. That is, we believe that a business’ reputation is highly valued by the business itself, reflecting the market value at large. Similarly, as investors we believe that our power to take our invested capital elsewhere encourages corporate performance in our best interest. In theory, management is deterred from misconduct as a result of legislative and regulatory requirements through which perpetrators face both firm wide and individual penalties including substantial fines, loss of contracts, job loss, prison time or worse. But is all misconduct penalised equally?

No. Market participants have been shown to be more judicious and heavy handed in cases of financial misrepresentation and misappropriation, whilst cases involving the multi facets of consumer fraud feel a similar punch. An extreme example of this is the execution of two Chinese executives found guilty of conspiracy to enhance protein levels (using a fatal melamine cocktail) in dairy products. However given that third party crimes pay it can be concluded that when the secondary affected party has no impact on future cashflows (the environment for instance) there does not appear to be any ramifications above and beyond the direct costs incurred by fines, legal costs and operational losses. A confirmation of this is the comparatively small losses absorbed by BP following its oil disaster in 2010. Three consecutive months of oil pumping into the Gulf resulted in incomprehensibly catastrophic damage to marine wildlife and the environment at large − damage not worn by the BP brand nor by any individuals at the helm. So if lying, cheating and stealing contribute to the bottom line it seems the market gives the metaphorical ‘thumbs up’. Until you can mandate what matters most to the market, moral martyrs probably don’t even make it past the post.

Jenna Moore is an Honours student at Queensland University of Technology.

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