Big profits can fuel bad corporate behaviour, new research shows

Hubris and overconfidence caused by excellent financial performance is a major driver of irresponsible corporate behaviour, according to new research.

Di Fan, a senior lecturer at the business school of the Australian National University, said his research showed companies making above-average profits were more likely to breach their environmental or social obligations than run-of-the-mill firms.

He said internal corporate governance had failed to curb bad behaviour and, based on his earlier research of US companies, fines needed to be increased as much as sixfold to encourage better behaviour.

Fan’s research, published in a paper co-authored with colleagues from Spain, Ireland and Hong Kong, comes amid fallout from widespread corporate misconduct in the financial services sector, and scandals over wage underpayment in various other industries. Company executives are under political pressure to resist activists who demand environmental, safety and governance issues be taken more seriously.

Australia’s banks are facing billions of dollars in costs to remediate customers they ripped off by providing poor services including shoddy financial advice and junk insurance, while one of the country’s biggest retailers, Woolworths, says it will spend up to $300m to compensate a group of workers it has underpaid for as much as a decade.

Fan said his research found that companies were more likely to breach environmental and social regulations if they were either financial under-performers or – counter-intuitively – over-performers.

Under-performers were under economic pressure to “take shortcuts” to catch up financially, he said. But in the case of star companies, “we find that it is hubris behind this tendency”.

“They are overconfident that when they do those illegal things they will not get caught,” he said. “They should have resources to maintain environmental and safety procedures, but we find that even though they have resources, they do not use them.”

He said the internal control systems of companies had failed and it was up to regulators and shareholders to put pressure on executives to do the right thing.

“Fines could be a way to do that,” he said. “In our earlier research we found that fines are actually quite low.”

Tying executive pay to corporate social responsibility (CSR) measures has been controversial in Australia, with some large investment funds rejecting the use of so-called “soft” measures of performance.

However, Fan said remuneration structures that forced chief executives to have skin in the game by owning a lot of shares in the company could help force better behaviour.

“Practicing good CSR is an expectation from customers and shareholders,” he said. “If any CSR scandals come out, the share price will decrease. If the CEO has a lot of stock, those stock price decreases will immediately affect the personal wealth of the CEO.”