The Hypocrisy Penalty: When Companies Talk the Talk, but Don't Walk the Walk

Category Business

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This study finds that when companies talk about their supposed virtue, but then act unethically, their share prices decline more than if they had simply not talked about it. This 'Hypocrisy Penalty' is especially prevalent in companies that investors do not expect will perform well in the future. The study encourages companies to be more conscious about walking the talk in regards to their ethical behaviors.

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Stock investors punish companies caught doing something unethical a lot more when when these businesses also have a record of portraying themselves as virtuous. This hypocrisy penalty is the main finding of a study we recently published in the Journal of Management. Companies often espouse their supposed virtue – known as "virtue signaling" – usually with the aim of getting benefits, such as higher sales, positive investor sentiment or better employees .

The Standard & Poor's 500 contains 500 of the largest US stocks listed on the stock exchange

We wanted to know what happens when such companies then do something wrong. So we examined corporate communications and media coverage for every company in the Standard & Poor’s 500 to develop a comprehensive database of both virtue signaling and misconduct. To gauge virtue signaling, we conducted linguistic analysis of each company’s letters to shareholders. This is a form of computer-aided text analysis that identifies and categorizes language to draw inferences .

In the study, approximately 25% of companies in the sample engaged in misconduct in any given year

For example, we looked for words and patterns to identify conscientiousness, empathy and integrity and considered how language patterns developed over time. Each company received a score that reflected how much of their corporate communication was devoted to virtue rhetoric. We then examined over half a million news articles to identify unethical behavior, such as egregious events like a CEO’s being fired for sexual misconduct, but also less severe transgressions, like not treating employees fairly .

In relation to the stock market, clobbering is the act of heavily devaluing company stock when the company is found to have acted unethically

Finally, our study considered how shareholders respond. Specifically, we looked at price swings the day after the media initially reported the misbehavior. We found that share prices fell 1.5% overnight in response to unethical behavior when companies had engaged in lots of virtue signaling, compared with 0.4% for those that did less virtue signaling or none at all. For an average company, that difference amounts to over half a billion dollars in lost value .

The linguistic analysis used words like conscientiousness, empathy and integrity to determine how much virtue signalling each company had engaged in

Keep in mind, too, that these ethical violations are not uncommon events. About a quarter of companies in our sample engaged in this kind of behavior in any given year. Stated simply, bad things happen, and when they do the stock market will clobber those who do not seem to be walking their talk. Well, with one critical exception related to a company’s expected future performance. If investors anticipate that a company will perform well in the future, there is no hypocrisy penalty – the consequences of misconduct are the same for those that use virtue signaling and those that do not .

The study had over 500,000 news articles to help determine misconduct among companies in its sample

Apparently, shareholders are very concerned about executives who say one thing and do another – unless the company is expected to make lots of money, in which case there is little or no penalty for unethical behavior. Why it matters Many companies, and the CEOs who run them, publicly say they care a lot about their people, the environment and the communities around them, among other virtuous signals .

The study found that the stock market penalizes misbehavior more when a company has given off a lot of virtue signal than a company which had done less virtue signaling

For example, ice cream maker Ben & Jerry’s proudly declares that it seeks to "advance human rights and dignity, support social and economic justice for historically marginalized communities, and protect and restore the Earth’s natural systems." At th same time, many of these same companies may well have engaged in, or been accused of, unethical behavior. Our study suggests that companies need to pay more attention to walking the talk, on ethical and all other matters .

Otherwise, investors may punish them harshly. Also, it’s important to note that what we call “virtue signaling” can indeed be a useful way to drive ethical behavior in organizations – but companies need to be prepared to address potential and real ethical lapses in order to keep investors from punishing their stock.

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