The Effect of Internal Reporting Openness on Managers' Collusion

Firms have increasingly adopted open work environments. Although openness is thought to have benefits, it could also expose firms to an unanticipated cost. Specifically, an open internal reporting environment makes it more likely that managers will observe a colleague’s communications with senior executives. This increase in what one manager knows about another manager’s communication to senior executives could facilitate harmful employee cooperation, or collusion. To test whether internal reporting openness results in more collusion between managers, we examine an experimental setting in which two managers each make separate reports to the firm about cost information they know in common but that is unknown by the firm. Because both managers face the same truth-inducing contract, conventional economic theory predicts that they both will always report truthfully and will not collude regardless of reporting openness. However, using behavioral theory involving trust and reciprocity, we predict and find more collusion, and thus lower firm welfare, under an open versus closed internal reporting environment. More collusion occurs in the open reporting environment because both managers more often honor their non-binding agreements to collude to misreport costs. Thus, we document an important potential cost of internal reporting openness, suggesting that firms should consider whether the potential benefits of such openness outweigh the potential costs of increased collusion.

This seminar is organised by the Erasmus Accounting Research Group.