Financial Misconduct and Changes in Employee Satisfaction

In a recent paper, we use new and proprietary micro-data from company-ratings site Glassdoor for the period between 2008 and 2016 to investigate changes in employees’ perception of firms and managers during  periods of financial misconduct and after the public announcement of the misconduct. Employee satisfaction is crucial for firm productivity and also serves as a proxy for a firm’s ability to attract and retain top talent. It is reasonable to expect that public announcement of financial misconduct by a firm would have a negative effect on its employees’ perceptions of the firm. Moreover, employees, as insiders, may observe nonpublic and value-relevant information about their employers [Greenetal2019]. Thus, their opinions may help predict financial misconduct.

In the first part of our paper, we estimate the effects of the public announcement of misconduct on employees’ ratings of their employers. We find that the average rating of the company declines by 0.32 standard deviation (sd) in the years that follow the public announcement of misconduct. Employees’ perceptions about career advancement opportunities, compensation and benefits, and leadership are the most adversely affected aspects. The ratings of work-life balance and culture, and the percentage of employees recommending the employer also decline significantly, but the magnitudes are smaller. We also find that the effects are stronger among employees who have less education and shorter tenure.

Next, we discuss the potential economic channels behind the decrease in employee satisfaction after the announcement of misconduct. The first potential channel is the short-term litigation cost and the related stock-return drop. Penalties and litigation settlement costs following the public disclosure of misconduct lead to an immediate negative stock return and increase in financial distress, which may cause employees to be concerned about firm performance. The second channel could be reduced compensation and higher risk of layoff. The last possible channel pertains to long-term reputation damage. Companies care about how the public and the media perceive their brands, which represent an important subset of intangible capital (e.g., Barth et al. [1998]). Firm reputation is damaged after the public disclosure of financial misconduct, and this damage would adversely affect a firm’s long-term performance.

We conduct some analysis to figure out which channel could be the primary driver. We first show that, although employees adjust their ratings downward right after the announcement of misconduct, the magnitude of this adjustment is small, and their ratings continue to decrease afterwards. This finding implies that changes in employee ratings do not mainly reflect the short-term litigation cost or related stock-return crash. Moreover, we also find that employee ratings are not positively associated with yearly abnormal stock return, which implies that employees do not adjust their ratings mainly based on employers’ stock return. Furthermore, we examine the impact of a firm’s misconduct on employee salaries. After an announcement of misconduct, salaries are not affected on average in the long run, although in the short run, wages decline for employees with low education or short tenure, non-regular workers, young workers, or workers outside the firm’s headquarters’ state. This outcome indicates that decreased compensation only affects employee ratings in the short run, if there are any effects. Based on the above evidence, litigation cost, stock-return drop, and compensation or layoff channels may affect changes in short-term employee satisfaction after the disclosure of misconduct. However, the reputation damage channel is likely the primary driving force in the long run because a damaged reputation would affect firms for a long time.

Furthermore, we investigate the effects of financial misconduct on employees’ perceptions of their firms during the years that misconduct is being committed. We find that employees’ overall rating during these years drops by 0.20 sd. Unlike our earlier results for the years following the announcement of misconduct, these effects concentrate among older employees and employees working in the state where the headquarters is located and among those who are more likely to hold managerial positions. This finding suggests that these employees are exposed to more private information while the misconduct is taking place. In contrast, other employees may only hear about the misconduct when it becomes public.

Given that some employees have private information when firms are committing fraud, we investigate whether employee ratings can help predict misconduct. For example, might employee reviews of Wells Fargo, during the years that they were engaging in financial misconduct, have predictive power? We follow the prediction analysis in [Dechow2010]. Indeed, we find that these ratings hold significant predictive power over conventional sources of financial data. In this sense, our results show how employee rhetoric and perceptions can serve as a signal for the integrity of a company.

This post comes to us from Yuqing Zhou, a PhD candidate at UCLA’s Anderson School of Management, and Christos Makridis, a visiting assistant professor at Arizona State University, a digital fellow at the MIT Sloan Initiative on the Digital Economy, a non-resident fellow at the Harvard Kennedy School of Government Cyber Security Initiative, and a non-resident fellow at the Baylor University Institute for Studies of Religion. It is based on their recent paper, “Financial Misconduct and Changes in Employee Satisfaction,” available here.