Designing an Effective: Peer-Reporting System

Article excerpt

Trust in American businesses has rarely been as fragile as it is today. Increasingly, the public perception is that too many corporate executives have committed flagrant breaches of trust by either turning a blind eye to questionable practices or actually participating in fraudulent practices. The Enron and WorldCom scandals at the turn of the century, followed nearly a decade later by the Wall Street excesses in derivative trading of mortgage-backed securities, contributed to the present lack of faith in the honesty of financial reporting and management practices. one important tool in preventing and detecting fraudulent activities is a peer-reporting system, known more colorfully as a whistleblowing mechanism. In fact, the discoveries of many of the biggest frauds in the early 2000s can be attributed to corporate whistleblowers.

While whistleblowing is not a modern phenomenon, its importance and relevance to the current business environment has resulted in considerable new research as to how employees react to programs designed to encourage whistleblowing and how employees can be motivated to participate in these programs. This research spans the academic disciplines of economics, psychology, human resource management, and accounting, and it includes surveys by nonprofit organizations such as the Ethics Resource Center (ERC) and the Association of Certified Fraud Examiners (ACFE). We incorporate the findings of many of these research studies to propose steps for designing an effective peer-reporting system.

WHISTLEBLOWING OR PEER REPORTING

The term "whistleblowing" can be used to refer to a variety of types of reporting by employees of the observed misconduct of others. Some of the most common types of activities include personal misbehavior, such as sexual harassment, discrimination, substance abuse, and other abusive conduct. Another subset involves reporting lapses in ensuring the quality of products produced, ensuring the adherence to regulatory protections for employees, or minimizing the effect on the environment of cutting corners during production. A third category involves ensuring honesty in interactions among customers, suppliers, and other businesses, such as reporting that special deals are being made with some suppliers but not others. In general, an employee who chooses to blow the whistle on these activities may have motivations other than money, although some financial rewards may exist under certain circumstances. These other motivations may include simply a desire to be employed by a company that is ethical and engaged ethically with other companies.

A fourth category of unsavory conduct can be defined generally as the illegal or unethical use of corporate resources, including the falsification of documents, employee misappropriation of assets, or other actions that directly affect the financial statements of the company. The estimated costs of employee fraud and theft range as high as $50 billion per year in the United States and as much as $2.9 trillion worldwide, according to a 2010 study by the Association of Certified Fraud Examiners. (1) The median fraud in this study was $160,000 and involved theft of assets, but at least a quarter of the frauds identified involved losses of more than $1 million. The higher the level of manager involved correlated positively with the size of the loss, and misstating financial statements was the category with some of the highest losses. Frauds lasted a median of 18 months, and they were detected by insider tips more than any other method.

Many of the current research studies looking into employee theft have focused on this type of misconduct because of its serious negative effect on firms' bottom lines. For this category, a formal system to encourage honesty and the obligation to report on the dishonesty of others may be designed to effectively use monetary rewards for the good of the business. Therefore, a peer-reporting system in a business context can be defined as one where managers give feedback to superiors on the performance of other managers and are compensated partially based on this feedback. …