The Research Brief is a short take about interesting academic work.

The big idea

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. 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. 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.

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.

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.

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.

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 the other end of the political spectrum, restaurant chain Chick-fil-A proclaims that it is “about more than just selling chicken”; its corporate purpose: “To glorify God by being a faithful steward of all that is entrusted to us.”

Whether from the right or the left, this virtue signaling establishes, and implicitly promises adherence to, a set of ethical standards. What happens, though, when behavior does not align with virtuous talk?

Academics have two decidedly different views about how to answer this question. Some contend that virtue signaling buffers companies from the negative ramifications of misconduct. Another perspective suggests that there’s a more severe adverse reaction whenever anyone deviates from expectations. Think, for example, of the special vehemence reserved for the priest who pilfers from the church coffers.

Our study confirms that the latter – a hypocrisy penalty – is more likely what is happening.

What’s next

We are now exploring different types of shareholders and how they respond to organizational behavior – and misbehavior. For example, social activist funds could be especially put off when companies in which they invest behave badly, whereas the most powerful institutional investors are less likely to be concerned about a mismatch between a company’s words and deeds.

The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.