Assignment: Detect, Identify, and Define Reporting Fraud (5-6 pages)

The Ethics ‘‘Fix’’: When Formal Systems Make a Difference

Kristin Smith-Crowe • Ann E. Tenbrunsel •

Suzanne Chan-Serafin • Arthur P. Brief •

Elizabeth E. Umphress • Joshua Joseph

Received: 30 June 2011 / Accepted: 12 December 2013 / Published online: 14 January 2014

� Springer Science+Business Media Dordrecht 2014

Abstract This paper investigates the effect of the coun-

tervailing forces within organizations of formal systems

that direct employees toward ethical acts and informal

systems that direct employees toward fraudulent behavior.

We study the effect of these forces on deception, a key

component of fraud. The results provide support for an

interactive effect of these formal and informal systems.

The effectiveness of formal systems is greater when there

is a strong informal ‘‘push’’ to do wrong; conversely, in the

absence of a strong push to do wrong, the strength of

formal systems has little impact on fraudulent behavior.

These results help to explain why the implementation of

formal systems within organizations has been met with

mixed results and identifies when formal systems designed

to promote ethical behavior will be most efficacious.

Keywords Ethics � Formal systems � Fraud � Informal systems � Unethical behavior

Introduction

First comes the scandal, then comes the public outrage, and

then comes the big fix: beefing up the formal systems to

keep companies honest. Pattern sound familiar? A quick

perusal of newspaper headlines from just the last several

decades reveals a cyclical pattern of corporate scandal,

public outrage, and corporate atonement (Berg 1983;

Blumenthal 1983; Carroll 1985; Gerth 1980; Halloran

1985). Arthur Anderson, Enron, Tyco, WorldCom, and,

more recently, Goldman Sachs were preceded by General

Electric, Investors Overseas Services, Lincoln Savings &

Loan, Sears, and Shoney’s. These all are companies that

have grabbed headlines by doing wrong, illustrating that

wrongdoing in corporations is not a present fad. Neither is

the fix.

Organizations and financial institutions implicated in

ethics scandals typically attempt to regain public trust by

recasting themselves as ethical entities. The envisioned

path toward this recasting, while varied, seems to converge

on establishing or, in some cases, re-establishing formal

structures to ensure and enforce ethical behavior. The

Sarbanes–Oxley Act passed by the United States Congress

is one example of these changes, resulting in enhanced

formal control systems and the requirement of a chief

compliance officer at all 9,000 publicly held corporations

(Hurt 2005), thus directly affecting formal systems within

organizations. Management observers have predicted that

K. Smith-Crowe (&) � A. P. Brief Eccles School of Business, University of Utah, Salt Lake City,

UT, USA

e-mail: mgtksc@business.utah.edu

A. P. Brief

e-mail: arthur.brief@business.utah.edu

A. E. Tenbrunsel

Mendoza College of Business, University of Notre Dame,

Notre Dame, IN, USA

e-mail: atenbrun@nd.edu

S. Chan-Serafin

Australian School of Business, University of New South Wales,

Sydney, NSW, Australia

e-mail: s.chan-serafin@unsw.edu.au

E. E. Umphress

Foster School of Business, University of Washington,

Seattle, WA, USA

e-mail: eu4@uw.edu

J. Joseph

Partnership for Public Service, Washington, DC, USA

e-mail: JJoseph@ourpublicservice.org

123

J Bus Ethics (2015) 131:791–801

DOI 10.1007/s10551-013-2022-6

the ‘‘new agenda’’ would be comprised of ‘‘greater

investment in financial systems, ethics training, and cor-

porate governance’’ (Byrne 2002). Providing an even more

recent example of the emphasis on the formal systems

‘‘fix,’’ the Obama administration’s initiative in response to

the 2008 global financial crisis includes revamping finan-

cial regulation aimed at discouraging further greed and

risky bets by Wall Street firms (Appelbaum and Herszen-

horn 2010; Plender 2009; Scannell 2009).

The million dollar question is will these formal systems

work? To date, the research on the effectiveness of formal

systems within organizations has been mixed, with some

ethics programs producing discernible effects on behavior

and others having no effect (for a review see Tenbrunsel

and Smith-Crowe 2008). We posit that the primary reason

for the unpredictable effectiveness of ethics programs is

that the designers and implementers focus on formal sys-

tems, one component of an organization’s ethical infra-

structure (Tenbrunsel et al. 2003), to the exclusion of other

important components of the ethical infrastructure. One

such ignored aspect is the informal systems of the orga-

nization, such as pressure from peers and colleagues to

behave unethically, including fraudulent behaviors. We

argue that to better understand when formal systems to

promote ethics will be effective, unethical and fraudulent

behavior in organizations needs to be recognized as a

product of an interaction between formal and informal

organizational forces. Empirically, we investigate the

effects of two countervailing forces that exist in some

organizations: formal systems that pull individuals toward

ethical behavior and informal systems that push them

toward fraudulent behavior.

Specifically, we consider the interactive effect of these

systems on deception, a key component of fraud, which is

defined by the Oxford English Dictionary (1989) as ‘‘the

quality or disposition of being deceitful; faithlessness,

insincerity.’’ Though the term fraud is sometimes used in a

more strict criminal sense, here we use the term in a

broader sense of acts of bad faith that may or may not

constitute legal violations. Certainly, such acts can be quite

harmful to organizations in terms of damage to reputation,

litigation, and so forth, regardless of their legal status.

Interestingly, despite the pervasiveness of deception and its

harmful effects on organizations, it has remained largely

unaddressed in organizational research (Grover 2005;

except in the contexts of negotiation and lie detection, e.g.,

Eckman and O’Sullivan 1991; Tenbrunsel 1998; Aquino

and Becker 2005).

In addition to focusing on a rarely studied, though key

component of fraud (deception), this paper offers several

contributions. First, the constructs and hypotheses are

theoretically derived largely from research on ethical

infrastructure and social information processing; we also

acknowledge some of the parallels between formal and

informal systems as we discuss them in our study, and

formal and informal systems as discussed in institutional

theory. Importantly, however, the scope of our theorizing is

limited to formal and informal systems as they exist within

specific organizations and not at the level of institutions.

Our theoretical approach addresses previous criticisms

regarding the atheoretical approaches to these issues (i.e.,

see Tenbrunsel and Smith-Crowe 2008). Second, we pro-

vide the first empirical investigation of the interaction

between formal and informal systems as they exist within

organizations. Third, our findings shed light on the incon-

sistent findings regarding the effectiveness of formal sys-

tems in organizations on unethical behavior (see

Tenbrunsel and Smith-Crowe 2008). We thus extend our

current understanding of the effectiveness of formal sys-

tems, providing insight into the ethical infrastructure of

organizations and its impact on fraudulent behavior.

Theoretical Background

An organization’s ethical infrastructure incorporates mul-

tiple components, including formal and informal systems

(Tenbrunsel et al. 2003). Formal systems are the tangible

objects and events pertaining to ethics that are purposefully

designed and implemented, whereas informal systems are

the unofficial policies, practices, and procedures that are

relevant to ethics. Examples of the former include ethics

training programs and advice hot lines that recognize eth-

ical behavior as an important organizational attribute,

whereas examples of the latter include the implicit pressure

from co-workers, supervisors, and top management to

engage in ethical or unethical behavior. Distinguishing

between, and focusing on, the formal and informal com-

ponents of the ethical infrastructure is consistent with

institutional theory, which classifies institutions as either

formal or informal (Coase 1998; Helmke and Levitsky

2006; North 1990). Formal institutions represent explicit

codified contracts and rules that govern exchanges within

society, while informal institutions represent implied, often

unwritten conventions, norms, and behavioral codes

(Helmke and Levitsky 2006; North 1990). We take a

similar view of formal and informal systems, where one is

codified and explicit, and one is not. Yet we do not seek to

study these systems at the institutional level, rather our

focus is on these systems as they exist within organizations.

While formal and informal systems can be ‘‘good’’

(promoting ethical behavior) or ‘‘bad’’ (promoting unethi-

cal and fraudulent behavior), in this paper we focus on one

particular combination of the two: formal systems that pull

the employee to do right and informal systems that push

the employee to do wrong. Due to legal liabilities,

792 K. Smith-Crowe et al.

123

organizations are much more likely to have formal systems

that promote ethical rather than unethical behavior. Given

the likelihood then that organizations’ formal systems

focus on promoting ethical behavior, it is important to

consider the countervailing force of an informal system

that focuses on unethical behavior. Indeed, it is such

pressure toward unethical behavior that formal systems are

designed to combat. Further, within formal systems we

focus on two components—training and ‘‘hot lines’’—

which allow for an interactive communication of codes of

conduct and ethical values (versus the mere existence of

static, and often ‘‘boiler plate’’ codes of conduct; see

Loughran et al. 2009). In this sense, we are focusing on

those indicators of a formal system that would be expected

to be especially impactful. 1

Within informal systems, we

focus on the informal pressures that individuals experience

to behave unethically; such pressure is the essence of

informal systems (cf. Tenbrunsel et al. 2003).

Here it is important for us to note two things. First, our

conceptualizations and measures of formal systems that

promote ethical behavior and informal systems that pro-

mote unethical behavior rest on the assumption that that

good and bad are not necessarily opposites – they can be

qualitatively distinct. Our view is informed by Bradley

et al. (2008, p. 179; see also Paine 2003) who pointed out

that ‘‘…behaviors defined as good, for instance, are not necessarily the polar opposite of those defined as bad.

Theft, for instance, is a bad action that has no correspon-

dent in the goodness category because abstaining from

theft is not enough to be labeled good.’’ Similarly, we do

not conclude that the absence of a formal system that

promotes ethical behavior constitutes a formal system that

promotes unethical behavior, or that the absence of an

informal system that promotes unethical behavior consti-

tutes an informal system that promotes ethical behavior.

Second, our paper concerns the interactive effects of formal

and informal systems as they currently exist in organiza-

tions. Our scope does not extend to a discussion of the

emergence of these systems (see DiMaggio and Powell

1983; Kraatz and Block 2008; Scott 1991). Below, we

briefly review previous research and theory on formal and

informal systems, and then develop a theoretical argument

for why we expect that the two systems interact to predict

fraudulent behavior.

Formal Systems and the Pull Away from Fraudulent

Behavior

Drawing on Pugh et al. (1968), formal systems are defined

as those that ‘‘are documented and standardized, visible to

anyone inside or outside the organization’’ (Tenbrunsel

et al. 2003, p. 288) and they are carried out through formal,

administrative channels (Lange 2008), a staple of organi-

zations’ ethical infrastructure. Importantly, formal systems

vary in strength across organizations, with some organi-

zations employing stronger formal systems with numerous

components and other organizations employing weaker

systems with few features. As these systems are public and

can be observed from outside of the organization (e.g., by

customers), they tend to convey messages that pull the

employee toward ethical behavior and away from fraudu-

lent behavior. Hence, here we focus on formal systems that

promote ethical behavior rather than unethical behavior.

Formal systems constitute an important part of the eth-

ical infrastructure because individuals look to their orga-

nizations for guidelines regarding what constitutes

appropriate behavior (Schneider 1975). Official commu-

nications, such as training and advice ‘‘hot lines,’’ provide

one source for this information (Jansen and Van Glinow

1985). These formal mechanisms allow organizations an

opportunity to promote ethical behavior and guard against

fraudulent behavior (Ferrell and Gresham 1985; Trevino

1990). Indeed, it has been found that formal systems can

decrease the unethical behavior of employees within

organizations (Kish-Gephart et al. 2010; McCabe et al.

1996). Yet, as we previously noted, research on the

effectiveness of formal systems has produced mixed

results, an inconsistency that we argue can be better

understood by considering their interactive effect with

informal systems. Below, we discuss the influence of

informal systems on fraudulent behavior and then argue

that one must consider both formal and informal systems

when predicting how and when they will influence uneth-

ical behavior.

Informal Systems and the Push toward Fraudulent

Behavior

Informal systems can be thought of as emitting ‘‘signals

regarding appropriate ethical conduct that are received by

the organizational members’’ (Tenbrunsel et al. 2003,

p. 288), and like formal systems can vary in strength across

organizations. In contrast to their formal counterparts, the

signals conveyed through informal systems do not entail

official pronouncements or actions, but rather they are

‘‘felt’’ by organizational members (Lawler and Rhode

1976; Lange 2008; Selznick 1943). Informal systems rep-

resent the unofficial messages regarding ethical norms

1 For instance, based on dialogical theories of learning, Burke et al.

(2007) have argued that leaning is a social activity that is facilitated

by social interaction. Specifically, in the context of safety training,

Burke et al. (2006) demonstrated that more learning takes place when

trainees have opportunities to interact with each other and the trainers

(getting feedback from trainers, etc.) compared to more passive forms

of training like watching a video. The selection of training and ‘‘hot

lines’’ as two aspects of formal systems are interactive and thus

consistent with this definition.

The Ethics ‘‘Fix’’ 793

123

within the organization, obtained in part via socialization

and the process of social learning (Ashforth and Anand

2003; Brief et al. 2001; Burgess and Akers 1966; Palmer

2008; Warren and Smith-Crowe 2008) in which employees

learn through conversations with peers and management

and through observation what is considered ethical and

what is not. Like formal systems, informal systems provide

people with the behavioral guidelines they seek so that they

will know how to act appropriately in their environments

(Schneider 1975). The norms espoused by these informal

systems may or may not be ethical. Our focus is on the

latter case: systems that push employees to do wrong, and,

thus, may exist in tension with the aforementioned formal

systems. The power of informal systems that reinforce

unethical behavior is illustrated in the demise of Enron and

Arthur Anderson. At Enron, Mr. Lay made it clear that

informal systems trumped formal systems (Barrioneuvo

2006):

Ethical rules that he had helped set up at En-

ron…somehow did not apply to him, Mr. Lay sug- gested. When questioned by Mr. Hueston on Tuesday

about a $160,000 personal investment he made in a

photo-sharing company that did more than 80 percent

of its business with Enron, Mr. Lay called sugges-

tions of impropriety ‘‘form over substance.’’ Rules,

he said, ‘‘are important, but you should not be a slave

to rules, either.’’

The importance of informal systems is consistent with

branches of institutional theory (Helmke and Levitsky

2006; Knack and Keefer 1997; Lauth 2000; North 1990)

and social information processing theory (Salancik and

Pfeffer 1977, 1978). At the macro level, research on the

impact of informal institutions on political structures

(Lauth 2000) and transaction costs (Knack and Keefer

1997) has demonstrated the importance of considering

those systems that exist ‘‘outside officially sanctioned

channels’’ (Helmke and Levitsky 2006, p. 5), yet have a

tremendous potential to affect significant sociological

processes that exist within a society (North 1990). Simi-

larly, at a more micro level and more relevant to our focus

on systems within organizations, the social information

received from peers plays an important role in individuals’

attitudes, perceptions, and behaviors. For instance, Roy

(1952), a sociologist studying the informal systems in a

steel processing company, described the social pressure to

under produce as he experienced as a radial-drill operator

when he over produced. Roy was censured by a fellow

worker who said, ‘‘What’s the matter? Are you trying to

upset the apple cart?’’ (p. 431). Economists are similarly

finding that social pressures can influence behavior (e.g.,

cooperation and productivity) beyond what would be pre-

dicted simply on the basis of monetary incentives

(Bandiera et al. 2005; Dal Bo and Dal Bo 2010). Further, in

a recent meta-analysis (Kish-Gephart et al. 2010), psy-

chologists found that organizational members’ perceptions

of what their organizations expect and what values they

espouse in relation to ethics (essentially, organizational

level ethical climate and culture, respectively) were mod-

erately to strongly, negatively correlated with unethical

behavior, providing additional evidence that organizational

members are strongly influenced through informal, social

channels.

Informal systems regarding unethical behavior are per-

haps best captured by the pressure that employees feel from

their peers, supervisors, and top management to violate the

organization’s published values. Pressure from these

groups informally communicates the values that the orga-

nization ‘‘really’’ espouses. Indeed, conformity pressures,

which include both informal surveillance to see who is

behaving ‘‘right’’ and the accompanying sanctions, have

been implicated in organizational wrongdoing (Sutherland

1983; Brief et al. 2001). A good case can thus be made that

informal systems are an important force. Yet, formal and

informal systems coexist within organizations. While one

can predict main effects for each system, we argue below

that it is their interactive effect that is important in pre-

dicting fraudulent behavior.

Interactive Effects of Formal and Informal Systems

To assert that there is an interactive effect between formal

systems that promote ethical behavior and informal systems

that promote fraudulent behavior is not a foregone conclu-

sion. Empirically, to our knowledge, there has been no

demonstration of their interactive effects. Theoretically, the

relationship between formal systems that promote ethical

behavior and informal systems that promote unethical

behavior has been characterized in two contradictory ways:

as primarily independent (see Tenbrunsel and Smith-Crowe

2008 for a review) or as primarily interdependent (Cross-

land and Hambrick 2011; Keefer and Knack 2005; Miller

and Form 1980). The latter characterization is most ger-

mane to our theoretical arguments and predictions.

Miller and Form (1980, p. 362) provide an apt

description of the importance of considering both systems

at the same time:

The student of social organization needs to know how

both formal and informal organizations operate. The

relationship between these two types of organization

is not supplementary, but interactive. In a very real

sense, then, it is impossible to understand how the

supervisory structure actually operates without sys-

tematic knowledge of the ongoing informal relations

in it.

794 K. Smith-Crowe et al.

123

This assertion, which rests on interdependence between the

two systems, and more specifically, on the notion that

formal systems are interpreted within the context of

informal systems, finds support in institutional theory

(Dobbin 1994; Keefer and Knack 2005; Crossland and

Hambrick 2011) and social information processing theory

(Salancik and Pfeffer 1977, 1978). Informal norms are

argued to be the initial force guiding transactive exchanges

in small, homogenous societal groups. As the groups grow

larger and more diverse, formal institutions (i.e., contracts,

codes of conduct, etc.) emerge to facilitate these pre-

existing informal institutions so that societal members can

trade safely with those who are dissimilar or unfamiliar

(North 1990; Bates 2001); however, the development of

these formal institutions is argued to be constrained by the

informal norms that preceded them (Dobbin 1994). Infor-

mal institutions are thus seen as more primary and deep

seated than formal institutions (Keefer and Knack 2005),

and, as such, act as a constraint on formal institutions

(Crossland and Hambrick 2011).

A social information processing perspective, which

posits a central role of the influence of the social context on

job attitudes, asserts that the social environment provides a

template that individuals utilize to interpret complex

environmental cues (Salancik and Pfeffer 1978). Salancik

and Pfeffer (1978) further argued that objective informa-

tion, such as that on job variety and autonomy, actually

lacks meaning unless it is interpreted within a social con-

text and as such cannot be used in isolation to predict job

attitudes (cf. Burke et al. 2006, 2007). Thus, the social

context dictates the meaning of the more objective infor-

mation conveyed by formal systems. We agree with these

assertions and, applying them to the domain of fraudulent

behavior, predict that the impact of formal systems can

only be fully understood when one considers the informal

systems within which the formal systems operate.

In the context of institutional theory, Scott (1987)

indicated, however, that the nature of this formal–informal

interaction potentially can take several forms: ‘‘Formal

structures purposefully designed to regulate behavior in the

service of specific goals are seen to be greatly affected—

supplemented, eroded, transformed—by the emergence of

informal structures’’ (p. 54). Making use of the parallels

between formal and informal systems at the institutional

level and at the organizational level, the same logic can be

applied to thinking about formal and informal systems

within organizations. Here, we investigate two possible

interaction effects: informal systems may either increase or

decrease the effectiveness of formal systems. 2

Increased Effectiveness

On the one hand, it could be argued that formal systems are

made more effective by informal systems. In other words,

formal systems designed to pull employees toward ethical

behavior only have meaning, and, thus, efficacy, when

there are strong informal systems pushing employees to

behave unethically. A social information processing per-

spective is based on the premise that job characteristics are

socially constructed and that it is the intrinsic features of

the situation that help makes sense of the extrinsic features

of the job (Salancik and Pfeffer 1977). Given that informal

systems have been linked with intrinsic processes and

formal systems with extrinsic processes (Tenbrunsel et al.

2003), this line of reasoning suggests that when the infor-

mal system to do wrong is weak, formal systems designed

to enforce ethical values lack meaning, and, thus, have

relatively little impact as there is no context within which

to understand why such behavior is being prescribed. That

is, when there are no informal pressures to behave uneth-

ically, a strong formal system to behave ethically will be

out of place and lack significance. In contrast, when there

are strong informal pressures to do wrong, the prescribed

behavior espoused by a formal system to do right has

meaning as it is interpreted within the social context of the

pressure exerted by the informal norms.

In this sense, a formal system to do right exists to

countervail an informal system to do wrong. This argument

is consistent with Roberts’ (2001) discussion of corporate

governance in which the ideal use of formal systems is as a

‘‘fail safe device’’ for fixing informal mechanisms that are

broken. Along these lines, we argue that formal systems

will be more effective when the informal system has gone

awry (i.e., when informal systems that encourage unethical

behavior are strong). This line of reasoning suggests the

following hypothesis:

H1a Informal systems promoting fraudulent behavior

will strengthen the negative relationship between formal

systems that promote ethical behavior and fraudulent

behavior.

Decreased Effectiveness

Conversely, it is possible that the effectiveness of formal

systems is made less effective by the presence of strong

informal systems. This argument is consistent with the

inverse relationship posited between extrinsic and intrinsic

motivation, such that a strong intrinsic motivation is seen

as diminishing the perceived effect of an extrinsic moti-

vator and vice versa (Calder and Staw 1975). Under-

standing informal systems to be more intrinsic than formal

systems (Tenbrunsel et al. 2003), an increase in the

2 As Scott (1987) notes, formal systems may also be transformed, or

changed by informal systems. As this paper focuses on a single point

in time, this possibility is not investigated.

The Ethics ‘‘Fix’’ 795

123

strength of the informal system should make formal sys-

tems less effective in curbing fraudulent behavior. It has

been found that the codes of conduct are less effective

when they are inconsistent with the informal norms of the

organization (McCabe et al. 1996); thus, the effectiveness

of a formal system that pulls toward ethical behavior will

be diminished when it faces opposition with an informal

system that pushes toward unethical behavior. It has also

been argued that formal constraints are stronger when the

informal constraints are relatively weaker, such as in more

developed countries where the rule of law is more salient

(Peng 2002; Crossland and Hambrick 2011), suggesting an

inverse relationship between formal and informal systems.

Indeed, Elffers et al.’s (2003) investigation of regulatory

compliance in the Netherlands demonstrated that individ-

uals complied with the law more when they were aware

that social norms for non-compliance were weak (i.e., weak

informal systems). More specifically, this line of reasoning

suggests the following hypothesis:

H1b Informal systems promoting fraudulent behavior

will weaken the negative relationship between formal

systems that promote ethical behavior and fraudulent

behavior.

Below we describe a study designed to test our two

competing hypotheses regarding the possible interactive

effects of formal and informal systems on fraud. We

investigated fraud in terms of instances of deception

including falsifying records, withholding information,

misreporting information, and lying to stakeholders. Fol-

lowing the description of our study, we report our results,

which indeed indicate that the relationship between formal

systems that promote ethical behavior and fraud (i.e.,

deception) is moderated by informal systems that promote

fraudulent behavior.

Method

Sample

The data used in the current study were collected by the

Ethics Resource Center via their ‘‘2000 National Business

Ethics Survey’’ (2000 NBES; Joseph 2000). The 2000

NBES was administered via telephone interviews con-

ducted with a nationally representative sample of 1,500

U.S. employees between November 1999 and February

2000. Only data from employees of for-profit organizations

working at a location with one or more other employees

were included in our study. The final sample included 974

respondents of which 80.4 % were White, 8.3 % were

Black, and 6.2 % were Hispanic. Over half (51.5 %) of the

respondents were male and just under half (42.7 %) were

between 31 and 45 years of age. Over half (55.2 %) had

some post-secondary education (i.e., completed at least two

full years of college), 46.1 % served in management or

supervisory positions, and 86.4 % had been in their orga-

nizations for over a year.

Measures

Formal Systems to Promote Ethical Behavior

Two items assessed whether participants’ organizations

provided training on their standards of ethical conduct, as

well as specific telephone lines where advice concerning

business ethics issues could be obtained (0 = no, 1 = yes).

Because the items comprising this scale are dichotomous, we

computed Cronbach’s (1951) alpha using the upward bound

limit of phi (/max) rather than the Pearson r coefficient (Sun et al. 2007). The estimate of internal consistency was .92. To

construct the scale, we summed the responses to the items.

Informal Systems to Promote Fraudulent Behavior

Three items assessed the extent to which participants

agreed that they felt pressure to violate their organizations’

ethical standards from their co-workers, supervisors, and

top management, respectively (1 = strongly disagree,

2 = disagree, 3 = agree, 4 = strongly agree). Cronbach’s

(1951) alpha for this scale was .92. To construct the scale,

we summed the responses to the items.

Deception

Four items assessed whether participants had observed

different instances of deception (0 = no, 1 = yes): falsi-

fying records and reports; misreporting actual time or hours

worked; withholding needed information from employees,

customers, vendors, or the public; and lying to employees,

customers, vendors, or the public. Because these items are

dichotomous, we used Sun et al.’s (2007) modified version

of Cronbach’s (1951) alpha in order to calculate a more

accurate estimate of internal consistency. The internal

consistency estimate for this scale which is composed of

dichotomous items was .93 (Sun et al. 2007). To construct

the scale, we summed the responses to the items.

Control Variables

We controlled for various factors that impact reports of

unethical behavior in organizations (see O’Fallon and But-

terfield 2005; Trevino et al. 2006; Tenbrunsel and Smith-

Crowe 2008 for reviews). Consistent with recommendations

by Becker (2005), we provide a brief rationale for the

inclusion of these variables. Organizational tenure (1 = less

796 K. Smith-Crowe et al.

123

than a year; 2 = 1 to 2 years; 3 = 3 to 5 years; 4 = 6 to

10 years; 5 = 11 or more years) and position in organization

(1 = non-supervisory position; 2 = first line supervisor;

3 = middle management; 4 = senior management) were

included as prior research has demonstrated that they are

negatively related to moral reasoning (Elm and Nichols

1993; Ponemon 1990). Respondents who have longer tenure

and are in higher positions in the organization compared to

their counterparts with less tenure and in lower positions, we

argue, will have less ability to morally reason and thus also to

observe and report incidences of deception. Gender

(1 = male; 2 = female) also was controlled because some

research has shown that women are more ethically aware

than men (Ameen et al. 1996); as such women may have

been more likely to recognize incidences of deception than

men. Organizational size (1 = 2–24; 2 = 25–99;

3 = 100–499; 4 = 500–1999; 5 = 2000–9999; 6 = 10,000

or over) was controlled, as there is empirical research

showing that as organizational size increases, unethical

decisions also increase (Weber 1990). Organizational size

thus may be positively related to deception. Finally, orga-

nizational disruption (0 = no merger, acquisition or

restructuring; 1 = merger, acquisition, or restructuring with

no layoffs; 2 = merger, acquisition, or restructuring with

layoffs) was included as a control variable because events

such as layoffs and mergers are highly stressful for the

organization and its members (Brockner et al. 1993),

potentially causing competition between organizational

members. Such competitive environments have been argued

to raise one’s ‘‘moral antennae’’ thus sensitizing one to

incidences of deception (Butterfield et al. 2000).

Results

We conducted a confirmatory factor analysis in order to

examine the distinctiveness of the scales used to measure the

main study variables: formal systems, informal systems, and

deception. The three-factor model demonstrated a good fit

v2 = 56.79, df = 24, p \ .001; CFI = .99, TLI = .98, RMSEA = .04. All the indicators loaded significantly onto

their corresponding latent constructs (standardized path

estimates range was .40 to .94), which demonstrates that the

latent constructs are clearly distinct from each other. Fur-

ther, results of the Chi square difference tests suggest the

three-factor model had a better fit than either the two-factor

model combining formal and informal systems Dv2 = 167, Ddf = 2, p \ .001, and any other conceivable two-factor models, or the one-factor model Dv2 = 564.79, Ddf = 3, p \ .001. Descriptive statistics and correlations for all study variables are reported in Table 1.

We tested our hypotheses using multiple regression and

centered predictor variables. The results are presented in

Table 2. Consistent with previous research and theory,

Model 2 indicates a significant negative correlation

between formal systems and deception, and a significant

positive correlation between informal systems and decep-

tion. However, of greater interest here, Model 3 indicates a

significant interaction effect of formal and informal sys-

tems on deception. Supportive of Hypothesis 1a, the rela-

tionship between formal systems and fraudulent behavior

was stronger when informal systems were strong and

weaker when they were weak (see Fig. 1). Analysis of the

simple slopes (Aiken and West 1991) one standard devia-

tion above and below the mean for informal systems

yielded consistent results: the relationship between formal

systems and deception was stronger when informal systems

were strong b = -.15, p \ .01 versus weak b = .01, p [ .05.

Discussion

Our aim in this paper was to provide a systematic inves-

tigation of two components of the ethical infrastructure of

organizations—formal systems that pull individuals toward

Table 1 Means, standard deviations, and intercorrelations for study variables

Variable M SD 1 2 3 4 5 6 7

1. Organizational tenure 3.15 1.38

2. Position in organization 1.85 1.05 .20**

3. Gender 1.48 .50 -.10** -.10**

4. Organizational size 3.41 1.86 .05 -.22** .04

5. Organizational disruption .61 .74 .02 -.15** .02 .36**

6. Formal systems 1.00 .84 .06 -.08* .02 .41** .16**

7. Informal systems 3.46 1.36 .02 -.13** -.02 .08* .19** -.05

8. Deception .84 1.17 .01 -.09** -.03 .11** .20** -.10** .46**

* p \ .05; ** p \ .01

The Ethics ‘‘Fix’’ 797

123

ethical behavior and informal systems that push employees

toward unethical behavior—so as to further our under-

standing of when formal systems are likely to be effective.

We proposed that to predict fraudulent behavior, the

interactive effect of formal and informal systems within

organizations must be considered. That is, the less visible

yet more intrinsic informal components of the ethical

infrastructure influence the effectiveness of formal sys-

tems. Inspection of this interaction demonstrated that the

efficacy of the formal systems depended on the perceived

pressure to do wrong: when the informal pressure was

strong (or high), formal systems were efficacious, but when

the perceived pressure to do wrong was weak (or low),

formal systems did not predict fraudulent behavior.

These results suggest that a formulation of the optimal

level of formal systems designed to promote ethical

behavior must account for the organizational environment

in which these control factors operate. When the informal

push to do wrong is strong, ‘‘pulling’’ out all the stops in

the formal systems seems to make sense. But when the

pressure to do wrong is weak, extensive formal systems

may only be a waste of time and money. Thus, the adage,

‘‘if it ain’t broke, don’t fix it,’’ may be more than just a

cliché.

Limitations

An interpretation of these findings must certainly

acknowledge the limitations of the study. First, like any data

that are cross-sectional, it is difficult to draw inferences

about causality and no such inferences are intended. Further,

self-perceptions of formal systems are utilized, rather than

objective measures. The use of such perceptions allows for a

consistency between informal and formal systems (i.e., it is

difficult to get an objective measure of informal systems),

but it should be clearly understood that our findings are

driven by perceptions of such systems. Despite the disad-

vantages of cross-sectional data, and the limitations noted,

this type of data does have the advantage over experimental

studies of being able to translate the results much more

readily into reality (Seligman 1996). Given the difficulty of

getting reports on unethical behavior outside of the lab

(Cowton 1998), we believe that these data offer unique

insights into the ethical infrastructure of organizations, but

we also recognize the need for additional research that uti-

lizes objective measures and allows for causal inferences.

Second, our data are based on participants’ reporting of

all variables in one survey. As such, concerns about com-

mon method bias are reasonable, yet steps were taken

during the data collection and analysis processes that

should mitigate this problem. Procedurally, our data col-

lection was consistent with suggested approaches for

avoiding common method bias (Podsakoff et al. 2003).

Specifically, respondents were guaranteed anonymity, steps

were taken to reduce respondents’ evaluation apprehension

(e.g., there were no value laden/judgmental words used in

the survey and the interviewers merely asked respondents

for their opinions and thoughts about ethics at work), and

the items that constitute the three study variables were

scattered across the survey. Empirically, a confirmatory

Table 2 Results of the regression analysis

Model 1 Model 2 Model 3

Control variables

Organizational tenure .00 -.02 -.01

Position in organization -.07 -.01 -.01

Gender .00 .01 .00

Organizational size .07 .13** .12**

Organizational disruption .17** .10** .10**

Main effects

Formal systems -.14** -.14**

Informal systems .41** .39**

Interaction term

Formal 9 Informal systems -.09**

R 2

.05 .24 .25

DR2 .05 .19 .01

DF 8.67** 95.51** 7.24**

* p \ .05; ** p \ .01 Note. Unless otherwise indicated, the numbers in the table are stan-

dardized regression weights

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

low high

Formal Systems

D ec

ep ti

on

Informal Systems low

Informal Systems high

Fig. 1 Interaction effect of formal systems and informal systems on deception

798 K. Smith-Crowe et al.

123

factor analysis was conducted to ensure that the three study

variables were indeed distinct from one another.

Finally, our analysis and the corresponding implica-

tions are limited to specific components of the ethical

infrastructure—formal systems, which promote ethical

behavior, and informal systems, which promote fraudulent

behavior—and the specific items which we utilized to

represent these constructs. The items we examined within

each construct do not represent the full spectrum of for-

mal and informal systems, and, as such, future research

should investigate whether other components of these

systems exhibit the same relationships found within this

study. We also did not examine formal systems which

promote fraudulent behavior (though we think that these

are relatively uncommon) or informal systems that pro-

mote ethical behavior; we believe that future research that

investigates these aspects of formal and informal systems

will help add to our understanding of formal and informal

systems. Keeping in mind these limitations, the results do

highlight important organizational and theoretical

implications.

Theoretical and Practical Implications and Directions

for Future Research

We believe this research makes significant theoretical and

practical contributions. By theoretically examining the

ethical infrastructure, its components and their interactive

effects, we address calls for a more theory-based approach

to ethics in organizations (Tenbrunsel and Smith-Crowe

2008). To provide a platform for future research, we uti-

lized a theoretically driven classification of formal and

informal systems. Furthermore, because of their potential

interactive effects, we considered it essential that these

components be examined in conjunction with one another

rather than as part of isolated studies as has historically

been the case. As our findings suggest, these components

interact with one another, meaning that drawing conclu-

sions about the effect of one element in the absence of the

other is likely to be problematic. The importance of con-

sidering formal and informal systems simultaneously is not

only applicable to the study of ethical behavior in organi-

zations, but also to the theoretical framework offered by

social information processing theory, which we drew upon

to derive our predictions.

The organizational implications of these findings are

directly connected to the theoretical contributions. Just as

future researchers need to recognize the interdependent

influence of each of the identified components, so do

managers. Considered in isolation, formal systems may

appear to have a positive impact on fraudulent behavior.

However, when there is little push to do wrong via infor-

mal systems, extensive formal systems may just be a waste

of resources. This finding is useful in understanding why

research on the effectiveness of formal systems has pro-

duced mixed results. Focusing on formal systems exclu-

sively, while ignoring informal systems can lead to

unnecessary costs and frustration for organizations truly

committed to discouraging unethical behavior. Organiza-

tions that find that their formal systems do not impact

behavior may erroneously conclude that formal systems

are never useful and may be unlikely to rely on them

in situations in which they would be most effective,

namely when they are in the presence of informal pres-

sures to do wrong. Further, we encourage future research

that seeks to refine our understanding of the interactive

effects of formal and informal systems, specifically

research that considers the varying effectiveness of dif-

ferent components of formal and informal systems. Such

research would be informative in highlighting components

of formal and informal systems that are more or less

influential in themselves, and how these components of

varying influence then interact with each other. We also

encourage research that explores different combinations of

formal and informal systems, such as formal systems that

promote fraudulent behavior and informal systems that

promote ethical behavior.

The results also suggest that an organization cannot

simply ‘‘borrow’’ another organization’s ‘‘formal’’ ethics

plan, but rather must consider the appropriateness of a plan

in its own unique context (i.e., in the context of its par-

ticular informal systems). This recommendation resonates

with similar thinking at the institutional level (Shirley

2005, pp. 629–630):

[the] stickiness of beliefs and norms explain why

underdevelopment cannot be overcome by simply

importing institutions that were successful in other

countries. There are numerous examples of failure.

Latin America copied the U.S. constitution, transi-

tional countries emulated U.S. or European bank-

ruptcy laws and commercial codes…all with very different and generally disappointing results.

Likewise, we argue that within an ethical infrastructure, a

formal system cannot be copied or even mandated without

first understanding the informal system in which it will be

embedded.

The findings suggest that there is no quick fix to scan-

dals and wrongdoing—organizations must engage in the

hard work of understanding if there are strong informal

systems that promote fraudulent behavior. Likely, this

conclusion is not what organizational leaders want to hear;

it is, however, a message that they must hear if they truly

desire to exact change. We hope that our research provides

a blueprint for how such an informed understanding can

help achieve that change.

The Ethics ‘‘Fix’’ 799

123

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