Sean David Williams

For CEOs, Integrity Is the Best Policy

A new study co-authored by Yale SOM’s Thomas Steffen analyzed tens of thousands of shareholder letters to reveal whether executives’ actions typically live up to their promises. It found that firms whose CEOs scored well on this measure of integrity tended to perform better, while facing lower audit fees.

When Elon Musk took to Twitter in 2018 to declare—prematurely, it turned out—that Tesla had secured funding to go private, it began a series of events that led to an SEC fine and his removal as chairman

Modern business leaders do more than run companies—a CEO’s public statements and reputation for integrity can influence a company’s future. But precisely how performance and integrity are linked is difficult to analyze objectively. 

In a new study forthcoming in the Accounting Review, Thomas Steffen, assistant professor of accounting at Yale SOM, and three co-authors set out to quantify CEOs’ integrity by capturing the degree to which their actions live up to their promises. The team, which also included Shane Dikolli of the University of Virginia, Thomas Keusch of INSEAD, and William Mayew of Duke University, came up with a novel method for estimating how often CEOs keep their word by examining the words they use in public communications. And, the study shows, this metric of an executive’s integrity correlates with their firms’ future performance. 

Read the study: “CEO Behavioral Integrity, Auditor Responses, and Firm Outcomes”

“Prior research has shown the importance of high-level executives in terms of setting the tone at the organization and the company culture,” Steffen explains. “That’s what got us thinking about how CEOs’ integrity would ultimately influence the economic situation of their companies.”

Previous studies have largely relied on employee surveys or focus groups to assess questions such as whether CEOs keeps their promises. But such studies are both expensive and time-consuming, and can only span small numbers of companies. Integrity is multi-faceted, encompassing traits such as honesty, fairness, morality, and more. It’s “really hard to evaluate,” Steffen says. 

Steffen and his colleagues chose to focus on one specific aspect of integrity: how much CEOs’ words are perceived to align with their actions, which is known as behavioral integrity. The team built a database of more than 30,000 annual shareholder letters penned by CEOs of various companies between 1987 and 2012. Unlike legal documents or other disclosures that have been vetted by other teams at a company, the annual shareholder letter is a short, more personal note that could plausibly be attributed to CEOs themselves. “Of all the documents that come out of a company, this letter seemed like a good place to look for the CEO’s personal influence coming through,” Steffen says.

Behavioral integrity is closely linked to the concept of trust, he adds. If someone typically fails to keep their promises, those around them will see that person as less trustworthy. As a result, such a person might have to offer more explanations in order to maintain trust. On the other hand, people who usually keep their word and follow through on actions would generally not need to explain themselves as much. The presence or absence of these explanations could offer a clue to whether a CEO’s actions and words were congruent, Steffen explains. 

“If a person has a track record of not keeping their word, you might demand they explain themselves more before you believe them,” he says. “Our thought was that looking at the degree to which the CEO offered explanations could link back to their behavioral integrity.”

Of course, CEOs need to explain events or actions to shareholders for a wide range of reasons, such as the company’s age, its performance, the complexity of its business model, and so on. The researchers first analyzed the letters’ text for explanatory words, such as “because,” “hence,” and “therefore.” They then constructed a model to explain the prevalence of these words based on a slew of factors that might cause CEOs to offer more explanations, including company-specific reasons as well as personal ones, such as the CEO’s age.

Once the team accounted for explanations that could be attributed to these factors, the shareholder letters still had residual amounts of explainer words—that is, words or phrases that couldn’t be justified for any obvious reasons. If this proportion was high—that is, the CEO seemed to over-explain—it was a sign of lower behavioral integrity. Fewer explanations, on the other hand, served as a proxy for greater behavioral integrity. “Obviously a lot of how a CEO communicates is driven by what’s happening at the firm and in the industry,” Steffen says. “But after controlling for those factors, we could isolate the use of explanations that could be more directly attributed to the CEO.”

This metric of integrity correlated with a business’ bottom line. Firms whose CEOs had higher behavioral integrity performed better financially in the next business year. 

Overall, the team found that older CEOs typically offered fewer explanations. If a firm had performed poorly during the year, had higher levels of debt, or had greater variation in sales, the letter tended to carry more explanations. 

The team also correlated their measure of behavioral integrity with employee surveys and anonymized data from Glassdoor, a site where employees review workplaces. They found that CEOs who offered more residual explanations—and thus likely had lower behavioral integrity—also tended to have lower ratings, and employees expressed more negative reactions to these workplaces. 

The team’s metric of integrity also correlated with a business’ bottom line. Firms whose CEOs had higher behavioral integrity performed better financially in the next business year. 

The researchers also looked at audit fees over a 13-year period for the companies they studied. All publicly traded firms require audits, and the price of the audit can vary depending on the auditor’s estimate of potential costs. “Auditors are required to think about management’s integrity and how that might impact their findings,” Steffen says. “If an auditor thinks a particular audit is going to be risky or time-consuming, they’re likely to charge more.” 

The study showed those firms whose CEOs scored lower on the behavioral integrity metric indeed tended to pay more for audits. But firms that paid more didn’t have more fraud investigations or shareholder litigation, he adds, which suggests that the auditor may have been doing more work to prevent those things from happening. 

The work is an important step toward understanding the economic implications of a CEO’s integrity. But the results should be interpreted with caution, Steffen says. The metric of behavioral integrity they designed is an indirect measure, and “only speaks to that concept of congruence between someone’s words and deeds. It’s not the final word on all aspects of CEO integrity.”

Assistant Professor of Accounting