Influence

In September 2019, Volkswagen's (VW) CEO Herbert Diess, Chairman Hans Dieter Poetsch, and other executives and employees were charged, arrested, or forced to resign for allegedly hiding information about vehicles' emissions. These charges came almost four years after the US Environmental Protection Agency accused VW of selling diesel vehicles that polluted significantly above the level allowed by the US regulation, in a scandal known as Dieselgate. VW's initial reaction was to blame some employees for having installed defeat devices that allowed understating harmful emissions in official tests. This assertion was overturned in a 2016 lawsuit, which established the responsibility of VW engineers in installing defeat devices "with the knowledge and approval of their managers". VW's leadership was accused of having perpetuated a "stubborn and unrepentant culture" that gave rise to "systematic cheating and deception". An important question concerns the role of VW leaders in influencing employees' misbehavior. Did VW engineers align to a culture of dishonesty instilled by their leaders, or did they voluntarily hide emissions information regardless of the leaders' directives? Would different leaders have led to a different course of action?

There is substantial evidence that corporate executives often misreport information to derive private benefits, and that this behavior is shaped by personal traits and preferences. For this purpose, a common practice is to adopt a reporting method based on self-disclosed information that prevents verification from external parties. The opposite case is to report information certified by a neutral third party, which makes an objective assessment with no room for manipulation.

Leaders' (fraudulent or transparent) reporting choices can influence organizational culture and ultimately financial performance. Nonetheless, the effect of leaders' reporting choices on organizational transparency is not yet well understood. This is mostly due to the fact that unethical behaviors are generally hidden from view and thus difficult to measure empirically. In addition, it is difficult to assess the link between leaders' actions and organizational culture given the non-random matching between leaders and organizations. The important but hitherto unsettled question is therefore whether leaders' reporting choices influence (un)ethical behaviors within their organizations. We fill this gap by investigating two interrelated research questions:

1. Do workers follow their leaders' reporting choices?
2. To what extent do leaders opt for ethical reporting?

Building on the research design in D'Adda et al., we use a laboratory study where subjects are randomly assigned the role of leaders or workers and clustered in four-person groups with one leader and three workers. We use a 3 × 2 between-subject design that varies the leaders' ability to: (i) choose the reporting method (mandatorily assigned vs voluntary chosen); and (ii) punish or reward workers by choosing how much of the group payoff is allocated to them ("incentive power"). Although our subject pool is formed by students (which is suboptimal relative to using real business leaders), our setting has the advantage of allowing us to directly observe how leaders influence workers' decisions.

In our setting, the leader moves first and the workers move simultaneously as second movers upon observing the leader's decision. We measure cheating as in Fischbacher and Follmi-Heusi: subjects are asked to privately roll a die and report the outcome, knowing that higher reported outcomes correspond to higher group profits, hence potentially higher individual earnings. The key feature of our design - and a novelty with respect to D'Adda et al. - is that before rolling the die, participants are asked to decide how to report the die-rolling outcome. Similar to Pate and Feltovich, our subjects can choose between two reporting methods: a computer draw ("automatic reporting") or a self-reported die roll ("self-reporting"). Under automatic reporting, subjects roll a virtual die, and the computer automatically reports the outcome on their screen, thus making any manipulation impossible. Under self-reporting, subjects secretly roll a physical die and report themselves the outcome on their screen. Here, cheating is possible, profitable (since payoffs are increasing in reported outcomes), and undetectable (since die rolls are unobservable by the experimenter and other subjects, except statistically). Opting for automatic reporting - instead of self-reporting - represents the ethical decision. This directly follows from experimental evidence that self-reporting attracts dishonest people as it allows hiding truthful information and cheating for private profits. Our design is similar to Feltovich wherein subjects - who play the role of price-setting firms in a competition game - can choose how to report their costs: by either die rolls made by the subject who inputs the outcome into the computer ("self-roll" treatment) or computer-simulated die rolls ("computer-roll" treatment). As in our setting, in Feltovich self-reporting is meant to capture unethical behavior.

While prior research has considered the mere action of cheating as a proxy for unethical behavior, our study speaks to a broader class of misbehaviors encompassing the action of hiding relevant information through reporting choices. Exploring the choice of reporting methods is crucial to understand the natural occurrence of fraudulent behaviors, as the probability of detecting fraud is largely endogenous to how a given outcome is reported. Our study analyzes this aspect by exploring in a lab context the influence of leaders in shaping workers' ethical behaviors through reporting choices.

Theoretical Background

Dating back to Hermalin, economic theories and experimental evidence have suggested that leaders can persuade others to follow their actions by setting an example of "the right" thing to do. Leading by example is "one of the most powerful methods to encourage individuals to work toward a common objective". Indeed, prior evidence reveals that leading by example has a positive effect on followers' voluntary cooperation in public goods games. This effect may have different origins, such as recognition of leadership as legitimate, perception of the leader as a role model, and rule-breaking aversion. Nonetheless, whether leaders' own example can also influence followers' ethical behaviors in an organizational context remains poorly understood.

Some insights come from the literature on business ethics, which reveals that ethical leaders have positive influences on subordinates and organizations. For example, Stouten et al. and Avey et al. show that ethical leadership reduces employees' deviant behaviors (e.g., bullying) and disregard of organizational norms.

Those studies draw upon social psychology theories of social learning (Bandura, 1997), which posit that ethical leaders can influence their subordinates by demonstrating the types of activities and behaviors that are expected and rewarded, hence encouraging followers to take those behaviors as models to mimic. According to this literature, followers are likely to emulate the behaviors of those who are higher in the organizational hierarchy because leadership forges one's credibility as a role model of normatively appropriate actions. Further evidence focuses on workers' perception of their leader's integrity, and the effect of such perception on their attitudes. White and Lean find that employees who perceive their leader as having a higher integrity level have lower intentions to act unethically. Similarly, Ho and Lin show that followers have higher ethical behavior intentions when they perceive their leaders as being engaged in ethical behaviors. The purpose of those studies is to assess the relationship between workers' perception of the leader's integrity and their intentions or attitudes toward unethical acts.

Here, we rather focus on workers' actual (un)ethical behavior after observing their leader's (un)ethical choices. In particular, we posit that leaders will affect subordinates' behavior through their own example, reducing fraudulent reporting choices. This result is expected to be strong especially when leaders make their reporting choice voluntarily (as compared to an exogenous assignment), i.e., leaders' personal imprint is necessary to influence workers. Hence, we hypothesize the following:

Hypothesis

Leaders' automatic reporting choices increase workers' likelihood of choosing automatic reporting, especially when the leaders choose to do so voluntarily.

Having established our main hypothesis, we explore a number of mechanisms to unpack the mechanisms at play. Existing theory provides a useful framework for baseline arguments but does not allow developing precise hypotheses. Hence, as is common in the literature in these instances, we adopt an inductive approach: we allow findings to emerge from our data without any intention to test specific theories.

First, we analyze whether subjects that are assigned to the role of leaders (as compared to the individual setting) are more likely to choose automatic reporting, perhaps owning to concerns of role modeling arising from having attained the leadership role. Second, we explore the role of leaders' instruments to influence workers' behavior. In many organizations, the most common of such instruments consists in having the power to administer rewards or punishments, which we refer to here as "incentive power". So, we analyze whether workers' reporting choices are influenced by the mere possibility for the leader to assign rewards and punishments. Also, we investigate how - and which type of - leaders use their incentive power. A carrots-and-sticks approach suggests that leaders may affect workers' actions by enacting a punishment threat: by choosing a different reporting method from that of their leader, they may fear receiving a lower share of the group payoff. Hence, we can expect workers to adhere more often to their leaders' choice when the latter can punish them by allocating a lower share of the group payoff (as compared to when workers receive an equal share by design).  Finally, we establish whether the leaders' automatic reporting choice can reduce cheating among workers (to validate our assumption that automatic reporting is the ethically superior choice).