Honesty Pays Off

Companies fare better when they honestly acknowledge their mistakes and don’t blame poor performance on others, according to a new research paper.
Companies fare better when they honestly acknowledge their mistakes and don’t blame poor performance on others, according to a new research paper. “Investors will accept a forthright recognition of an honest mistake, expecting that corrective actions are likely to follow,” says co-author Stephen Ferris, professor and senior associate dean at the Trulaske College of Business at the University of Missouri in Columbia. “When firms explain a negative event as due to an external cause, company leaders can appear powerless or dishonest to shareholders.”

Ferris wrote the study with Donald Chance, James C. Flores Endowed Chair of MBA Studies at the Ourso College of Business at Louisiana State University in Baton Rouge; and James Cicon, professor of finance at the University of Central Missouri in Warrensburg.

The researchers reviewed company announcements from 1993 through 2009 and identified 150 that described poor company performance. Of those, more than two-thirds at­tributed poor performance to external forces. After the researchers filtered out the instances in which companies legitimately could blame outside factors such as industry­wide downturns, they were left with “those firms that really had no one or nothing else to blame but themselves,” says Ferris. “Those companies accepting responsibility saw their share price stabilize over the next several months, while those that blamed others continued to experience falling share prices.”

Companies might point to external forces out of arrogance, pride, fear of litigation, or an inability to see the shortcomings of their leaders, says Ferris. But eventually many do hold their leaders accountable: Of those companies that blamed outside factors, 44 percent replaced their CEOs in the following year, compared to only 32 percent of those that accepted responsibility.

“Poor Performance and the Value of Corporate Honesty” is forthcoming in the Journal of Corporate Finance.