The impact of government integrity and culture on corporate leadership practices: Evidence from the field and the laboratory

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The impact of government integrity and culture on corporate leadership practices: Evidence from the field and the laboratory☆ Amon Chizemaa, , Ganna Pogrebnab,1 ⁎

a b

Birmingham Business School, University of Birmingham, Edgbaston, Birmingham B15 2TT, United Kingdom Birmingham Business School, Economics Department, University of Birmingham, Edgbaston, Birmingham B15 2TT, United Kingdom

ABSTRACT

To understand what drives corporate leaders to choose certain corporate governance practices there is need to look beyond the individual traits of the leader, examining the effect of the elements of the institutional environment on managerial decisions. Drawing on the contextual approach to leadership and insights from institutional theory, this study examines the impact of government integrity on corporate governance practices. From the field study, we find that government integrity has a positive causal effect on corporate leaders' corporate governance decisions and choices. The positive impact of government integrity on corporate leaders' actions is also confirmed using a laboratory study, showing that a social norm of promoting leadership integrity, positively impacts on corporate responsibility especially in contexts where the government lacks credibility. Specifically, we find that corruption and bribery by corporate leaders is low in contexts that are transparent and high in contexts with low government integrity.

Introduction What drives corporate leaders to choose certain corporate decisions or practices? Moreover, what influences the manner in which they effectively implement such decisions and practices in organizations? In an attempt to answer questions of this nature, previous leadership and corporate governance studies, employing a leader-centric approach, have focused on examining specific universal traits and behavioral styles that make some leaders more effective than others (Lord, Day, Zaccaro, Avolio, & Eagly, 2017). For example, upper echelons theory (Hambrick & Mason, 1984) and the literature on executive personality (e.g., Hiller & Hambrick, 2005; Peterson, Walumbwa, Byron, & Myrowitz, 2009) suggest that the leadership behaviors and decisions of senior executives are influenced by both demographic characteristics such as background, expertise, tenure, and age and by psychological characteristics such as personality. Consistent with this view, Hogan and Kaiser (2005) note that “who we are determines how we lead” (p. 175). As such, upper echelons theory points to the key role of the top management team (TMT) in shaping work processes and influencing organizational outcomes (Finkelstein & Hambrick, 1996; Hambrick & Mason, 1984). An omission in studies that have focused exclusively on the effects of individual characteristics of top leadership is the realization that

decisions are made within a given context (Johns, 2006; Rousseau & Fried, 2001). Indeed, studies that examine the effect of leaders' traits and behavioral styles without full consideration of the context are not necessarily invalid but incomplete. Separately and, at times, collectively, insights from institutional theory and contextual leadership (Johns, 2006; Oc, 2018) provide the basis on which a better understanding of the influence of context on managerial decisions and choices can be drawn. According to the institutional perspective, human and social behaviors, among other factors, are influenced by country-level institutions, such as norms, routines and historical patterns, which determine isomorphism among individuals and organizations (Chizema, 2008; DiMaggio & Powell, 1983; Scott, 2001). This sociological perspective is consistent with research in financial economics that has shown that country institutions or characteristics explain a large proportion of the variation of corporate governance indexes across firms (Stulz, 2005). For example, a study on corporate governance by Doidge, Karolyi, and Stulz (2004) demonstrates that country-level factors influence governance practices much more than do firm-or even industry-level data. Dyck and Zingales (2004) show that control premia vary systematically across countries. The strength of these observations is probably behind Davis' (2005) suggestion that the future of relevant corporate governance research should seek to understand the institutional context in which it occurs,

☆ We are grateful to the action editor as well as to 3 anonymous referees for many insightful comments and suggestions, which helped to significantly improve this manuscript. We are grateful for financial support awarded by the Research Support Fund from the College of Social Sciences at the University of Birmingham. Ganna Pogrebna also acknowledges financial support from the UKRI projects EP/P011896/2 and ES/R007926/1. ⁎ Corresponding author is also an Extraordinary Professor at The Gordon Institute of Management Science (GIBS), University of Pretoria, South Africa. E-mail addresses: [email protected] (A. Chizema), [email protected] (G. Pogrebna). 1 Alan Turing Institute, 96 Euston Rd, Kings Cross, London NW1 2DB, United Kingdom.

https://doi.org/10.1016/j.leaqua.2019.07.001 Received 1 February 2018; Received in revised form 1 July 2019; Accepted 5 July 2019 1048-9843/ © 2019 The Authors. Published by Elsevier Inc. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/BY-NC-ND/4.0/).

Please cite this article as: Amon Chizema and Ganna Pogrebna, The Leadership Quarterly, https://doi.org/10.1016/j.leaqua.2019.07.001

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in contrast to the more traditional agency or transaction cost perspective. In the same vein, Porter and McLaughlin (2006) suggest that leadership in organizations does not take place in a vacuum (the term “leadership vacuum” was first coined by House & Aditya, 1997, p. 445) but does so in organizational and country contexts. Following their call for research that should make context, “a primary object of interest, rather than treating it as almost an afterthought” (p. 571), a stream of research has since explored context in attempting to understand the effect of corporate leadership on firm decisions and outcomes (Bullough, Kroeck, Newbury, Kundu, & Lowe, 2012; Chizema, Kamuriwo, & Shinozawa, 2015). A common assumption in these studies is that the effectiveness of leaders' choices may be facilitated by some contexts and inhibited by others. Research on the macro context of leadership, discussed above, has considered both the effect of formal and informal institutions on leaders' choice of practices or decisions. Informal institutions are enduring systems of shared meanings and collective understandings that, while not codified into documented rules and standards, reflect a socially constructed reality that shapes cohesion and coordination among individuals in a society (Scott, 2001). A central construct from the context defined by informal institutions is national culture that constitutes created and learned standards for perception, cognition, judgment or behavior shared by members of a certain group or country (North, 1990). Culture refers to the “complex of meanings, symbols and assumptions about what is good or bad, legitimate or illegitimate that underlie the prevailing practices and norms in a society.” (Licht, Goldschmidt, & Schwartz, 2005: 233). Several attributes constitute or contribute to the whole construct of national culture. For example, government integrity, the quality of national governance in accordance with relevant moral values and norms which include consistency, coherence, and lawfulness and absence of corruption (OECD, 2013), relates closely to national culture. We, therefore, propose government integrity as yet another variant of informal institutions within the realm of macro context that potentially bears influence on corporate leadership's decision-making and the manner in which decisions are implemented. From public governance literature, government integrity has been variously defined as being consistent and coherent in principles, values, and action (Montefiore, 1999), following regime values and rules (Rohr, 1989), and acting in accordance with relevant moral values, norms, and rules (Huberts, Lasthuizen, & Peeters, 2006). Integrity is, therefore, an important factor and has been considered a necessary quality for governments to have (OECD, 2013). According to the OECD (2013), government integrity is the alignment of government and public institutions with broader principles and standards of conduct that contribute to safeguarding the public interest while preventing corruption. Thus, government integrity could also be observed through the quality of enforcement of a country's laws and regulations (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998; Rothstein & Teorell, 2008), suggesting that it is a public perception derived from the efficiency or non-efficiency levels of formal institutions. A commonly used proxy for government integrity, which we also use in this study, is the extent to which a state is free from corruption (Fredriksson, Neumayer, & Ujhelyi, 2007). According to Fijnaut (2002), corruption is an umbrella concept, covering all or most types of integrity violation or unethical behavior. We argue that government integrity, the mirror image of corruption, is, therefore, an informal institution and thus part of the context in which corporate leadership takes place. We seek to add to the stream of contextual leadership research by examining the effect of government integrity on corporate governance practices. We take the view that leadership is embedded in the context (Johns, 2006) and that it is socially constructed in and from a context where patterns over time must be considered and where history and

country institutions matter (North, 1990). As explained above, sociological perspectives provide explanations of the impact of contextual factors on leadership at the macro level where, collectively, typical actions, beliefs, desires and choices among members of society are constrained by informal rules or social norms (Hedstrom & Ylikoski, 2010). This approach is useful in understanding collective action at the national level, prompting Hedstrom and Swedberg (1998) to suggest that associations of macro factors can be better understood by examining the behavior, beliefs and decisionmaking of individuals in a given context. They suggest that the first step involves identifying the process through which situational or contextual factors constrain individuals' action. The second step is about identifying the action-formation mechanisms that link individual desires and beliefs to their actions or choices. The final step involves specifying the transformational approaches by which individuals, through their actions and interactions, generate various intended and unintended social outcomes. In this study, we explore the effects of macro factors on leadership choices through two complimentary methodological approaches. First, we use a field data analysis to show the macro-level association between government integrity and collective corporate leadership choices and outcomes. Second, we complement the first study by using a controlled laboratory experiment (e.g., Zizzo, 2010) to capture the whole chain of contextual, action-formation and transformation mechanisms of corporate leadership. This approach of using field data in conjunction with an experimental study has been previously employed in many impactful leadership papers (e.g., O'Reilly, Doerr, & Chatman, 2018; Steffens et al., 2018, to name a few). This paper makes at least three contributions to existing literature. First, we heed the calls to determine how national context and institutions shape corporate governance and leadership (Aguilera & Jackson, 2003), offering insights to comparative institutional analysis using field data. As such, we join the growing stream of literature that is transitioning from a-contextual research (Bamberger, 2008; Minichilli, Zattoni, Nielsen, & Huse, 2012) to the explicit consideration of contexts within the domain of leadership and corporate governance (Bullough et al., 2012; Chizema, Liu, Lu, & Gao, 2015). Second, by considering the impact of a macro-social context, through government integrity, on corporate governance practices, this study offers an alternative approach to the agency paradigm (Jensen & Meckling, 1976) that has largely dominated corporate governance studies. Finally, by conducting a controlled laboratory study, we test how social norm of contextual integrity impacts on leadership choices. The remainder of this paper is structured as follows. The following section provides a review of the contextual leadership literature, followed by one that discusses government integrity and theoretical explanations of organizational legitimacy. Hypotheses of the field study are then developed under the subsections. The next sections present the laboratory experiment that is used to support the field study, formulates experimental hypotheses and provides the main findings of the experimental study. The remaining part of the paper is devoted to a discussion of the findings, contributions, limitations with the conclusion at the end. A contextual approach to leadership In its broad sense, contextual leadership examines whether situational or contextual factors reduce or improve the impact of leadership practices (Oc, 2018). Moreover, it explores how leadership takes place in specific contextual settings. As described by Osborn, Hunt, and Jauch (2002), a contextual theory of leadership is one that recognizes that leadership is embedded and “socially constructed in and from a context” (p. 798), and they put it well as they further claim that, “leadership and its effectiveness, in large part, are dependent upon the context. Change the context and leadership changes” (p. 797) and the outcomes change too. 2

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In leadership research, several scholars have provided varied frameworks to understand context and its effect on leadership. For example, Porter and McLaughlin (2006) proposed seven components of the organizational context, including culture/climate, goals/purposes, structure and time. Ayman and Adams (2012) view leadership context through the lenses of cultural and organizational factors. According to Oc (2018), a comprehensive approach to the conceptualization of contextual leadership is one done by Johns (2006) who conceptualizes context at two different levels: the omnibus and discrete contexts. The omnibus context is about the broad environmental influences and provides answers to questions of a macro nature such as the what, why, who, when and where of contextual leadership (Johns, 2006; Oc, 2018). For example, under the where of the omnibus context, the researcher could consider national culture or institutional forces. In contrast, the discrete context is about specific situational variables that influence behavior directly or that are used to moderate relationships between variables (Johns, 2006). The discrete context focuses on aspects such as task, social, physical and temporal (Johns, 2006; Oc, 2018). For example, under the task of the discrete context, the researcher could consider task or job characteristics. From the two levels of Johns' (2006) conceptualization of contextual leadership, it is the omnibus context that relates to the heterogeneity of national settings and, indeed, one that is of interest to our study. As Oc (2018: 219) states, “…an omnibus approach to context will include studies that examine the top-down effects of societal trends, economic conditions, national culture, or other macro level factors.” As pointed out above, one of the dimensions of the omnibus context of leadership is the actual location where leadership takes place. Drawing on the omnibus context, some studies have considered contextual factors as a macro-level system-based constraint or enabler (e.g. institutional forces) that describes where leadership takes place, modelling their direct effect to explain variance in leadership or its outcomes across different contexts (Currie, Lockett, & Suhomlinova, 2009). For example, Bullough et al. (2012), drawing on institutional theory, sought to find the effects of six omnibus contextual factors, including business environment, societal development, economics, technology and physical infrastructure, political freedom and cultural variables, on women's participation in political leadership across 181 countries. Chizema, Liu, et al. (2015) draw on social role theory, employing three social institutional forces (women's representation in politics, economic environment, and religiosity) to explain the presence or absence of female directors on boards across 45 countries. More recently, Stoker, Garretsen, and Soudis (2019) show that across firms and countries, and controlling for individual managerial variation, the 2008 financial crisis led, on average, to an increase in directive leadership. Similarly, for a country-level study such as this current one, the omnibus context characterized by variation among countries' institutional settings provides a perfect theoretical framework to understand the effect of government integrity on the choices and decisions made by corporate leaders.

suggestion of starting by identifying the process through which contextual factors determine individuals' action followed by identifying the action-formation mechanisms that link individuals' beliefs and constraints to their choices. A core insight from institutional theory is that organizations strive for external legitimacy by complying with their social institutional contexts (Scott, 2008). From this effort, organizations expect their actions to be perceived as being “desirable, proper or appropriate within some socially constructed systems of norms, values, beliefs and definitions” (Suchman, 1995: 574). Without legitimacy, firms may not have access to resources that are important for their survival (Scott, 2001). To determine what constitutes legitimacy, firms rely on cues from the institutional environment. If institutional cues include corrupt or unethical practices, such corrupt practices may have an impact on a firm's actions in its search of institutional legitimacy (Keig, Brouthers, & Marshall, 2015). Government integrity, indeed, the central contextual factor under consideration in this study, belongs to the group of national institutions that are classified as informal (DiMaggio & Powell, 1983) and is a key institutional cue that potentially guides the behavior of firms in their search for legitimacy (Rodriguez et al., 2005). As pointed out earlier, in a national context, government integrity is a behavioral expectation of public institutions to conduct their business in a socially accepted manner. The absence of such an expected behavior manifests in corruption, a socially unacceptable situation, manifest in violation against the moral norms and values for political and administrative behavior (Fijnaut, 2002). In order to succeed in corrupt environments, corporate leaders may have to conform to institutional corruption pressures, gaining legitimacy in the eyes of corrupt government officials and with corrupt business partners (Ufere, Perelli, Boland, & Carlsson, 2012). In such environments, leading firms may have achieved their success through corrupt practices and through forces of mimetic isomorphism (DiMaggio & Powell, 1983), the rest of the firms in the same institutional environment may follow suit, suggesting a contagion effect of bad corporate practices. As corruption becomes normalized as a taken-for-granted behavior (Ufere et al., 2012), corporate leaders in low-government-integrity environments may embrace the same behavior in their decision-making and choices, manifesting through corporate irresponsibility. Ashforth and Anand (2003) argue that when corruption becomes institutionalized, it becomes an integral part of day-to-day activities to such an extent that individuals may be unable to see the inappropriateness of their behaviors. Here, the national environment of low government integrity becomes culturally accepted as normal by the collective of national actors such that the behavior at government level may influence and encourage that at the corporate level. For corporate leaders in environments with low government integrity, the logic of corporate governance strays away from notions of accountability, responsibility and transparency. There is evidence for this claim from previous studies. For example, Keig et al. (2015) argue that firms that establish and maintain operations in portfolios of locations characterized by higher levels of corruption are more likely to act irresponsibly, as such environments may allow or even encourage corporate leaders to side-step socially responsible behavior. In an earlier study, Tan (2009:174) pointed out that in environments where formal corruption flourishes due to lack of controls, firms “may become motivated to lower ethical standards, ranging from environmental negligence and abusive labor practice to corrupt human resource management”. In contrast, in a recent study, Ioannou and Serafeim (2012) found that firms headquartered in countries characterized by lower public sector corruption had higher levels of social responsibility. Moreover, competitive pressures in corrupt environments may push corporate leaders to make irresponsible decisions. Scholars have observed that operating in corrupt environments potentially increases direct and indirect transaction costs for the firm (Rose-Ackerman, 1975;

Government integrity, institutional legitimacy and corporate leaders' decision-making A suitable lens to explain firms' responses to government actions is institutional theory (Chizema & Kim, 2010; Rodriguez, Uhlenbruck, & Eden, 2005) and applying this perspective, that emphasizes contextual factors influencing corporate decisions, is an appropriate approach for our study. The use of institutional theory is also suited to our study because government integrity is an element of the norms and rules of states. We, therefore, draw on institutional theory to discuss the implications of government integrity or its absence for the firm's organizational legitimacy, consequently showing how the need for organizational legitimacy determines corporate leaders' decisions and choices. Our approach, here, is consistent with Hedstrom and Swedberg's (1998) 3

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Uhlenbruck, Rodriguez, Doh, & Eden, 2006). As Nwabuzor (2005:129) posits “companies that are burdened with under-the-table payments may try to contain their costs by cutting corners”. Ideally, any threat to a firm's survival in a corrupt environment may increase the likelihood that it will pursue irresponsible actions to remain viable (Campbell, 2007). Consistent with the overarching argument drawn on the contextual leadership and institutional theory, we argue that government integrity potentially impacts on the choice and effectiveness of corporate governance practices. For example, cross-country studies have shown corruption (the absence of government integrity) to be associated with higher corporate borrowing costs, lower stock valuations, and illegitimate and ineffective corporate governance practices (Ng, 2006). In the sections below, we provide explanation for the four hypotheses that government integrity impacts on corporate governance outcomes namely managerial accountability to shareholders and the board, auditing and financial reporting, protection of minority interests and corporate governance, in general.

Government integrity and auditing and financial reporting Auditing and financial reporting plays a potentially crucial role in corporate governance. This is because for investors to be more informed about their investments, basic accounting standards are needed to render company disclosures interpretable. Auditing and financial reporting are, therefore, about the transparency levels of corporations. Differences in the quality of auditing and financial reporting across countries have caught the attention of academics (e.g., Ball & Shivakumar, 2005). These differences, that scholars attribute to the national institutional setting for financial reporting (Brown, 2011), have been found even among countries that adopted International Financial Reporting Standards (IFRS). Ball and Shivakumar (2005) and Burgstahler, Hail, and Leuz (2006), among others, have argued that standards alone will not lead to substantially similar financial reporting outcomes and that such standards may be less important than other institutional features of the reporting and legal environment. Consistent with this view, Brown, Preiato, and Tarca (2014), who studied the effect of enforcement bodies and auditing with regard to financial reporting transparency in Europe, observe that culture and legal setting (including government integrity, see La Porta et al., 1998) will affect the output of financial reporting. Picur (2004) examines a sample of 34 countries and concludes that low quality of accounting is predisposed to a climate of corruption. In similar vein, Riahi-Belkaoui (2004) uses a cross-country longitudinal dataset covering the period 1985–1998 and observes that corruption creates a climate conducive to low quality accounting. Recently, Lourenço, Rathke, Santana, and Branco (2018) employ data from 33 emerging markets, concluding that country perceived corruption is related to higher incentives for firms to manipulate earnings. Moreover, extant work in international accounting argues that the strength of accounting quality is principally influenced by critical environmental factors such as economic forces, social forces, legal system, culture and political system (Doupnik & Salter, 1995; Nobes, 1998). The legal system, for example, is a typical formal institution and the perception of its strengths or weaknesses as well as its outcomes speak to the levels of government integrity (Rothstein & Teorell, 2008) with potential impact on firms' accounting practices. La Porta, Lopez-deSilanes, Shleifer, and Vishny (1998) observed that when a nation's legal system is relatively underdeveloped or if the legal code is enforced unevenly, respect for the law declines and economic transactions are generally disorderly and inefficient. However, there is a plethora of studies suggesting that enforcement mechanisms alone are not a sufficient condition to deliver effective financial reporting at a country level (Brown et al., 2014), calling for attention to contextual issues in accounting (Mazzi, Slack, & Tsalavoutas, 2018). We argue that government integrity is an important and relevant contextual factor in this regard. Indeed, government integrity is often seen in light of how the government discloses its actions to the public (Devas & Grant, 2003). Consistent with our main argument in this paper, government integrity is likely to drive corporate leadership in its policy and action on corporate accountability and disclosure. Managers might, therefore, be unable or unwilling to commit their firms to credible external verification of their income disclosures if the necessary infrastructure for such verification is not available.

Government integrity and managerial accountability to shareholders and the board Accountability is said to be necessary when actors' conduct impacts upon the rights or interests of others (Keay & Loughrey, 2015). In the case of firms, executives, who manage companies as agents, should be accountable to shareholders (Jensen & Meckling, 1976). This is because executives have considerable power over, and control of, the affairs of the company (Fama & Jensen, 1983). For example, they are in charge of the capital provided by shareholders as well as of any profits that firms generate. It is, therefore, necessary that executives account for their actions given the level of power and control they have over the principals' resources. But managerial accountability to shareholders is not ubiquitous, varying across countries due to different corporate governance systems (Aguilera & Jackson, 2003). For example, the Anglo-American model of corporate governance emphasizes shareholder supremacy (Hansmann & Kraakman, 2001). Going by the logic of shareholder-value maximization, with emphasis on the individual interest of the shareholder, managerial accountability should be expected to be higher in AngloAmerican models of governance than in stakeholder models of Japan and Germany (Chizema & Shinozawa, 2012). We argue that beyond the logic drawn on diverse corporate governance systems, government integrity potentially determines the extent to which firms in a given country context exercise managerial accountability on shareholders. We further argue that in national environments where government integrity is low, laws and regulations may not be effectively implemented thus failing to provide direction on how corporate leaders should behave. In such contexts where government corruption is pervasive (Rodriguez et al., 2005) corporate leaders may lose confidence in the word and action (Simons, 2002) of government authorities. Here, the failure of government officials to account for their actions to the citizens may be taken as an example by corporate leaders as they deal with shareholders and the board. Thus, the lack of government accountability, most likely through levels of government integrity, may suggest that corporate leaders may in turn fail to be accountable to shareholders and to the board of directors. Khatri, Tsang, and Begley (2006) found that, in the aftermath of the Asian financial crisis, corruption was endemic and that it led to weak corporate governance practices, with no regard for shareholders' interests. In contrast, Du, Li, Lin, and Wang (2018) found that government integrity is positively related to efficient corporate investment, a practice bound to benefit shareholders. We, therefore, hypothesize that:

Hypothesis 2. Government integrity will positively impact accountability and disclosure as measured in auditing and accounting reports. Government integrity and protection of minority shareholders The contextual effect of government integrity may also influence corporate leadership on how minority shareholders are protected across countries. La Porta, Lopez-de-Silanes, and Shleifer (2002) show that

Hypothesis 1. Government integrity will positively impact on managerial accountability to shareholders and the board. 4

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most firms outside the US are controlled by large shareholders who can extract private benefits from the corporations they control. A number of recent papers model this extraction of private benefits (Shleifer & Wolfenzon, 2002; Doidge, Karolyi, & Stulz, 2007; Stulz, 2005). Moreover, studying emerging markets, Young, Peng, Ahlstrom, Bruton, and Jiang (2008) argue that principal-principal agency problems, that is conflicts between large and small shareholders, exist in these economies because they typically do not have an effective and predictable rule of law which, in turn, creates a ‘weak governance’ environment (Dharwadkar, George, & Brandes, 2000, p. 650; Mitton, 2002, p. 215). Exploitation of minority shareholders by large owners, including family control, is therefore more severe in corrupt countries, that is, where government institutions lack integrity (Schleifer & Vishny, 1993; Zingales, 1994). Consistent with this view, La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1999) find that French civil law countries, which they claim to be relatively more corrupt, tend to have particularly poor protection of minority shareholders. In other words, the lack of government integrity is manifested in poor protection of minority shareholders as large owners either have no control from the authorities or bribe government officials to avoid any restrictions to their actions and choices (La Porta et al., 1999; Ufere et al., 2012; Young et al., 2008). Based on these arguments, drawn on extant literature, we hypothesize that governments that lack integrity, in other words, that are more corrupt, have less impact on the protection of minority shareholders.

GDP accounted for by the respective sector (Global Competitiveness Report, 2017–2018). Moreover, the companies from which the respondents are randomly selected, represent a good geographical coverage within a country. The survey is administered in a variety of formats, including face-to-face or telephone interviews with business executives, mailed paper forms and online surveys. This survey, conducted by WEF, is a reputable source of timely and vital information related to the business environment in which business executives operate in several countries. It is widely used in academic research (Van de Walle, 2006; Yang & Huang, 1990). The data from the survey gives a comparative qualitative picture of the economic and business environment of each country as provided by a representative group of business executives. The three measures used in this study are based on executives' responses on the following questions: 1) ManAcc: In your country, to what extent is management accountable to investors and boards of directors? [1 = not at all; 7 = to a great extent]. 2) AuditRep: In your country, how strong are financial auditing and reporting standards? [1 = extremely weak; 7 = extremely strong]. 3) MinIntrst: In your country, to what extent are the interests of minority shareholders protected by the legal system? [1 = not protected at all; 7 = fully protected]. We compute a fourth measure, Corporate Governance Index (CGI), as the average of the three WEF measures explained above. Given that several business executives provided responses to the questions above, over a period of four years, we need to establish whether these responses are both reliable (interrater reliability-IRR) and in agreement (interrater agreement-IRA). The presence of both reliability and agreement would justify our decision to aggregate yearly survey scores into single variables. Using STATA, we estimated ICCs, based on the one-way random effects. We report ICC estimates, the F-static and significance levels for the four dependent variables. First, the aggregation was justifiable for managerial accountability to shareholders and the board: F(92, 279) = 27.75; p > 0.01; ICC(1) = 0.87; ICC(2) = 0.96. Second, the aggregation for audit and accounting reporting was supported: F(92, 279) = 70.65; p > 0.01; ICC(1) = 0.95; ICC(2) = 0.99. Third, the aggregation for the variable on minority interests protection was justified: F(92, 279) = 62.61; p > 0.01; ICC(1) = 0.94; ICC(2) = 0.98. The aggregation for the fourth variable, CGI, was also justifiable: F(92, 186) = 7.34; p > 0.01; ICC(1) = 0.68; ICC(2) = 0.86. These ICC estimates (both for ICC1 and ICC2) are high suggesting the suitability of aggregating yearly survey scores into single variables. Because the ICC(1) index simultaneously measures IRR and IRA, LeBreton and Senter (2008) claim that high values may only be obtained when there is both absolute consensus and relative consistency in judges' ratings.

Hypothesis 3. Government integrity will positively impact on the protection of minority interests. The fourth hypothesis is a summary of the preceding ones, aggregating the three corporate governance outcomes. It is drawn on the central view that government integrity potentially dictates how corporate leadership behaves in determining the overall health of corporations in a country. Thus, high levels of government integrity or the state of a country's freedom from corruption translates into better corporate governance by firms hence: Hypothesis 4. Government integrity will positively impact on overall corporate governance practices. Field study methodology Data and measures Our study examines the potential impact of government integrity on national corporate governance practices. To achieve our objectives, we source data from a sample of 93 countries that were selected on the basis of available data on all the study's variables for the period 2011–2018.

Independent variable

Dependent variables

For this study, we employ government integrity (GovInt) as the independent variable. The score for GovInt is derived from Transparency International's Corruption Perceptions Index (CPI) for 2011 and is a measure of how corrupt public sectors are seen to be in countries (Fredriksson & Svensson, 2003). According to Transparency International, the index captures the informed views of analysts, businesspeople and experts in countries around the world. The CPI is based on a 10-point scale in which a score of 10 indicates very little corruption, thus high level of government integrity (Fredriksson et al., 2007), and a score of 0 indicates a very corrupt government. In scoring freedom from corruption, the Index converts the raw CPI data to a scale of 0 to 100 by multiplying the CPI score by 10. For example, if a country's raw CPI data score is 3.5, its overall freedom from corruption score is 35.

The dependent variables are about corporate governance practices namely, managerial accountability to shareholders and the board (ManAcc), strength of audit and accounting reports (AuditRep) and protection of minority interests (MinIntrst). Data for the dependent variables are drawn from the Global Competitiveness Reports of the World Economic Forum (WEF) for the years 2011 through 2018, for the 93 countries in our sample. The WEF draws its data from carrying out annual Executive Opinion Surveys of business executives who are randomly sampled from a large list of potential respondents from micro companies, small and medium-sized enterprises and large companies. The companies represent various sectors including agriculture, manufacturing industry, non-manufacturing industry (e.g., mining and quarrying, electricity, gas and water supply, construction) and services. The number of firms from each sector is in proportion to the share of

Control variables We use the logarithm of the five-year (2012–2016) growth rate of 5

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gross domestic product per capita as the basis of our measurement for level of economic development (GDP). We collect data for this variable from the World Bank Development Indicators, published on their website. We also use the logarithm of foreign direct investment inflows (FDI). The rationale for this control variable is that foreign direct investment influences the corporate governance of companies in the target country as governance practices are diffused from the country of origin. Moreover, previous studies have shown that countries with higher foreign equity inflows have a higher degree of protection of shareholder rights (Guillén & Capron, 2016). To control for this competitive kind of adoption, we included the logarithm of the average annual inflows of foreign direct investment for the years 2009 through 2016. Data on foreign direct investment inflows was collected from the UNCTAD. In addition, we employ a cultural dimension, the extent to which a given society is considered to be individualistic or collectivist (Hofstede, 1983), as a third control variable (Individualism). Corporate governance practices such as the use of independent directors on boards have their origin in countries that score highly on the cultural dimension of individualism. Examples include the US and the UK, and in such countries the purpose of corporate governance practices is to maximize value for the individual investor and not for the collective of other stakeholders (Aguilera & Jackson, 2003).

regressors in our model. We provide the rationale for each of the instruments we use in this study. We use legal origin as an instrumental variable for government integrity. In previous studies, legal origins have been used as instrumental variables for corruption (e.g., Fredriksson & Svensson, 2003; Pellegrini & Gerlagh, 2004). The variable is a categorical variable indicating whether a country has French, English, Scandinavian, German or Socialist legal origin. The justification for using legal origins as an instrument is its relationship with institutional efficiency as well as with the level of government intervention. La Porta et al. (1999) argue that more interventionist governments and less efficient bureaucracies should have higher levels of corruption, and hence lower levels of government integrity. For example, countries founded on English common law focus less on government intervention and place more emphasis on the protection of individual rights and should therefore have lower levels of corruption. La Porta et al. (1999) also argue that legal origins are exogenous to economic variables or institutions because they are mainly determined by historical factors (La Porta et al., 1999). For the endogenous variable (GDP), we use four instrumental variables. Two of these are on fractionalization: linguistic and religious. Linguistic and religious fractionalization measures are based on the probability that two randomly drawn individuals (from a country) are not from the same linguistic and religious group respectively. These fractionalization variables, drawn from Alesina, Devleeschauer, Easterly, Kurlat, and Wacziarg (2003), refer to the situation in the late 1980s and early 1990s. Scholars argue that highly fragmented countries on the basis of both language and religion are more likely to have poor economic development. For example, studies by Mauro (1995) and Easterly and Levine (1997) offer econometric evidence showing that greater levels of linguistic fractionalization hinder economic performance. The fact that the data on fractionalization variables were collected in the 1980s–1990s and the fact that the fragmentation of societies on the basis of language and religion cannot be changed by the dynamics of corporate governance in recent years, suggest that the averaged instrumental variables are exogenous. We use an exogenous geographical feature of countries (latitude) as a second instrument for economic development. Latitude, the distance from the equator measured in absolute degrees, affects climate and, therefore, aspects of agricultural productivity and disease. Previous studies have shown that countries closer to the equator are less developed. Latitude has, therefore, considerable explanatory power for the log of per capita GDP (Barro & McCleary, 2003), suggesting a positive relationship between latitude and economic development. Latitude is completely exogenous and can be used as an appropriate instrument as it can be changed neither by economic development nor by any level of shock from a disturbance. We also employ the situation of whether a country is landlocked (landlock) or not as an instrumental variable for economic development. Collier (2008) argues that the landlocked status is one of the four key factors preventing the poorest countries from growing and ripping the benefits of globalization. Moreover, gravity models point to a strong negative effect of landlockedness on bilateral trade (Coulibaly & Fontagne, 2006; Limao & Venables, 2001). As such trading costs are higher in landlocked countries thus constraining economic development. The fact that a country is landlocked cannot be affected by economic development, making it a good instrumental variable. The third endogenous variable, foreign direct investment (FDI), is instrumented by two measures of size: log population and log area. First, large populations provide a large market for products and services offered by multinational enterprises, have a large and cheaper labor force and a vast skills base (Billington, 1999). Large land area is likely to accommodate more foreign firms seeking to establish greenfield investment and potentially home to more resources that foreign firms seek to exploit. Foreign direct investment does not impact on country population, but the reverse, we argue, is true. Land area is finite, making a good instrumental variable for foreign direct investment. We

Model specification Using STATA, we conducted the following estimation. Given the linear regression: Y = β0 + β1X1 + … + β1Xn + ε, where Xi are endogenous variables - government integrity (GovInt), economic development (GDP), foreign direct investment inflows (FDI) and individualism, we first regress Xi on Z1 and Xi−1 to obtain Xi

Xi = y0 + y1 Z1 + …+ yn Zn + v

(1)

where Zi represents instrumental variables. We then plug in the fitted values of Xi derived from Eq. (1) into the original linear regression equation to estimate Eq. (2):

Y (corpgov ) =

0

+

1 X1

+ …+ 1 Xn + ,

(2)

where Y(corpgov) is represented by dependent variables (managerial accountability to shareholders and the board, auditing and financial reporting, protection of minority investors) and ν is a composite error term, correlated with X1 … Xn . As pointed out above, our regressors are potentially endogenous, that is they may be systematically related to unobserved causes of the dependent variable, in this case, corporate governance variables. Violations of this sort commonly occur when factors related to independent variables, that predict outcome, are dropped in estimation or when the independent variables themselves are measured with error (Wooldridge, 2002). Of course, two-way causation is yet another condition but not the only concern. For example, in the context of our study, it is plausible that government integrity could determine corporate governance practices as we hypothesize in this paper. However, the reverse is also likely to be the case as corporate governance practices such as the quality of auditing and accounting reporting could deter corrupt practices by government authorities. Moreover, within our model, government integrity could be a predictor of economic development. We thus used the 2SLS estimator, an instrumental variable (IV) method which is useful to purge coefficients of endogeneity bias (Baum, Schaffer, & Stillman, 2011) due to common methods, measurement error or simultaneity (Antonakis, Bendahan, Jacquart, & Lalive, 2010). Instrumental variables We identified instrumental variables for the four endogenous 6

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source data on population and land area from the World Bank Database. It is important for our model to justify the exogeneity of our instruments (population and area). While area is a geographical “hard” characteristic of a country and is unlikely to be influenced by other variables, the situation is not as straightforward for the population. For example, one could argue that population variable is not exogenous because it depends on FDI, that is, richer countries attract larger numbers of migrants and, therefore, these countries are likely to have higher FDI. Studies have found that FDI and migration often move in the same direction (e.g., Clemens & Williamson, 2000; Groznik, 2003; Lucas, 1990), however, several of these papers consider correlation rather than causality. Kim (2006), for example, investigated the link between migration, trade and FDI for the United States and concluded that FDI and trade are substitutes, but both are led by migration, suggesting that migration was an exogenous variable. Kugler and Rapoport (2005) distinguished between skills and unskilled labor movements and argued that skilled migrants positively influence FDI, but only in the long run. In order to further test the exogeneity of the population instrument, we collected data on immigration for 93 countries in our sample from the UN dataset2 as well as data on FDI for the same countries from the UNCTAD World Investment Report.3 Considering that the data on immigration was very fragmented after 2015, we captured data for the relative change in FDI from 2011 to 2015 as well as for the relative change in immigration for the same period in 79 countries in our dataset. We found that FDI decreased from 2011 to 2015 in 47 out of 79 countries. In 36 of these countries, migration also decreased and in 11 of them FDI increased. In 32 out of 79 countries FDI increased from 2011 to 2015 and in 26 out of 32 countries, migration declined whereas in 6 of them it increased. Fisher's exact test comparing countries with increased and decreased migration levels showed no statistically significant difference (Fisher's exact test p = 0.782). This provides additional support for our assumption of exogeneity of the population variable. For the fourth endogenous variable (individualism) we use a dummy variable of whether a country's primary language permits speakers to drop a personal pronoun (pronoundrop) when it is used as the subject of a sentence. In some languages, for example Spanish, pronoun drop is permitted. For example, the English sentence “I speak” may be translated into Spanish either as “Yo ablo” or simply as “Ablo” (Davis & Abdurazokzoda, 2016). In contrast, pronoun drop is not permitted in other languages such as English, as the pronoun “I” is required to make sense of the sentence. In such languages, the use of “I” signals that the person is highlighted as a figure against the speech context and its absence reduces the prominence of the speaker's person. As such the emphasis on the pronominal subject, especially I or you, in languages in which pronoun drop is not permitted is expected to be associated with cultural individualism (Davis & Abdurazokzoda, 2016; Kashima & Kashima, 1998). In contrast, the greater contextualization of the subject in languages that permit pronoun drop is expected to be associated with more collectivist cultures. Data on pronoun drop is based on an authoritative source of linguistic information, the World Atlas of Language Structures (WALS) and has been used in previous studies (e.g., Davis & Abdurazokzoda, 2016; Kashima & Kashima, 1998).

the set of dependent variables are high. All other correlations are modest. As explained above, we tested our hypothesis using ivregress of STATA to obtain 2SLS estimates. As suggested by several scholars (e.g., Antonakis et al., 2010; Larcker & Rusticus, 2010), we report both the OLS (see Table 2) and the 2SLS results (see Table 3). First, Table 3 shows OLS results. From our OLS results, as shown in Table 2, the coefficients for the effect of government integrity on managerial accountability to shareholders and the board (β = 0.02, p = 0.000), auditing and accounting reporting (β = 0.02, p = 0.000), protection of minority interest (β = 0.03, p = 0.000) and on the overall corporate governance index (β = 0.02, p = 0.000) are as predicted. Table 3 shows results for 2SLS tests. Joint tests including all endogenous regressors and their respective instruments provide a better explanation for the state of variables and for the suitability of their instruments. Starting with the instruments for the variable, government integrity, the coefficients on legal origins are significant and positive, as shown in Table 3, Model 1. Specifically, relative to the Socialist legal origin (dropped in the estimation), the coefficients for the rest of the legal origins are positive and significant: British (β = 11.22, p = 0.063), French (β = 8.97, p = 0.014), German (β = 22.97, p = 0.000), and Scandinavian (β = 25.93, p = 0.001). Coefficients of two instrumental variables used for the endogenous variable economic development are significant, as shown in Table 3, Model 2. Specifically, linguistic fractionalization (β = −0.73, p = 0.001) is negative and significant and as expected, latitude is positive and significant (β = 0.01, p = 0.030). From the two instrumental variables used for foreign direct investment (FDI), the size of a country's population is positive and significant (β = 0.10, p = 0.025). Finally, as stated earlier, we considered whether the dominant country language allows pronoun drop or not, where languages that allow pronoun drop are collectivist. The coefficient for the instrumental variable, pronoundrop (β = −0.20.49, p = 0.000) is positive and significant (as shown in Table 3, Model 4), suggesting that countries whose languages drop the pronoun ‘I' are not individualistic. We also carried out post-estimation tests to ascertain the strength of the first stage statistics, at equation level. The results, as shown in Table 3, show that that the employed instrumental variables are strong: Model 1 [F(11, 81) = 18.71, p = 0.000], Model 2 [F(11, 81) = 24.07, p = 0.000], Model 3 [F(11, 81) = 18.85, p = 0.000], Model 4 [F(11, 81) = 19.62, p = 0.000]. We also used Reg3 of Stata to determine the strength of instruments used for each of the endogenous variables: [F(4, 89) = 6.56, p = 0.000] for the instruments of GovInt, [F(4, 89) = 13.10, p = 0.000] for GDP, [F(2, 91) = 8.23, p = 0.000] for FDI and [F(1, 92) = 42.22, p = 0.000] for individualism. We turn to results for the full models or joint tests, that is, in the second stage of the 2SLS shown in Table 3. First, contrasting the results of the second-stage regression with OLS estimation, the Wu-Hausman test, for the full models, rejects the null that there is no endogeneity problem with OLS estimation for Model 5 [χ2(4) = 5.26, p = 0.001], Model 6 [χ2(4) = 5.27, p = 0.001], Model 7 [χ2(4) = 6.60, p = 0.000] and Model 8 [χ2(4) = 7.08, p = 0.000]. These results suggest that all the regressors are endogenous, suggesting that 2SLS estimation is preferred to the OLS estimation. Second, we examined the exclusion restriction (over-identification restriction) of the 2SLS model to ensure that the excluded instruments from the equation do not correlate with the disturbance of the dependent variable. The null hypothesis for the overidentification test is that the instruments are exogenous, in other words, uncorrelated with the error term. Thus, if the test statistic is insignificant, we fail to reject the null hypothesis. The over-identification Sargan test results are as follows: for Model 5 [χ2(6) = 5.64, p = 0.582], Model 6 [χ2(6) = 5.74, p = 0.570], Model 7 [χ2(6) = 12.36, p = 0.089] and Model 8 [χ2(6) = 7.25, p = 0.404]. These results indicate that the model

Results of the field study Tables 1a and 1b show the correlations, means and standard deviations of the variables used in this study, including dependent, independent, control and instrumental. As expected, correlations among 2 See https://www.un.org/en/development/desa/population/migration/ data/index.asp for more detail. 3 See https://unctad.org/en/pages/PublicationWebflyer.aspx?publicationid =2460 for more detail.

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Table 1a Field study means, standard deviations and correlations (part 1). Variable 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

ManAcc AuditRep MinIntrst CGI GovInt GDP FDI Individualism legor_uk legor_fr legor_ge legor_sc legor_so Ling-fractional Relig-fractional Latitude Landlock LnArea LnPopul pronoundrop

Mean

SD

1

2

3

4

5

6

7

8

9

4.94 4.92 4.33 4.73 50.25 9.23 2.88 39.84 0.32 0.44 0.17 0.05 0.01 0.33 0.43 24.43 0.11 12.20 7.21 0.70

0.63 0.78 0.73 0.68 20.99 1.36 0.24 22.40 0.47 0.50 0.38 0.23 0.10 0.20 0.24 26.66 0.31 2.04 0.70 0.45

0.89⁎⁎⁎ 0.83⁎⁎⁎ 0.94⁎⁎⁎ 0.77⁎⁎⁎ 0.62⁎⁎⁎ −0.40⁎⁎ 0.57⁎⁎⁎ 0.12 −0.27⁎⁎ 0.01 0.36⁎⁎⁎ −0.11 0.03 −0.12 0.12⁎ 0.05 −0.10 −0.27⁎⁎ −0.59⁎⁎

0.90⁎⁎⁎ 0.97⁎⁎⁎ 0.78⁎⁎⁎ 0.70⁎⁎⁎ −0.38⁎⁎ 0.57⁎⁎⁎ 0.11 −0.32⁎ 0.12 0.32⁎⁎ −0.12 −0.06 0.14 0.12 0.08 −0.21⁎ −0.32⁎⁎ 0.45⁎⁎

0.95⁎⁎⁎ 0.75⁎⁎⁎ 0.57⁎⁎⁎ −0.31⁎⁎ 0.50⁎⁎ 0.26⁎⁎ −0.34⁎⁎ −0.04 0.37⁎⁎ −0.20 0.06 0.14 0.05 0.02 −0.11 −0.21 −0.46⁎

0.80⁎⁎⁎ 0.66⁎⁎⁎ −0.38⁎⁎ 0.57⁎⁎⁎ 0.17 −0.33⁎⁎ 0.04 0.36⁎⁎⁎ −0.15 0.01 0.14 0.10 0.05 −0.15 −0.28⁎⁎ −0.51⁎⁎

0.79⁎⁎⁎ −0.41⁎⁎⁎ 0.63⁎⁎⁎ −0.08 −0.26⁎⁎ 0.22 0.39⁎⁎⁎ −0.06 −0.19⁎ 0.03 0.36⁎⁎⁎ −0.02 −0.20 −0.32⁎⁎ −0.52⁎⁎

−0.35⁎⁎⁎ 0.60⁎⁎⁎ −0.21⁎ −0.11 0.24⁎⁎ 0.31⁎⁎ −0.04 −0.43⁎⁎ −0.08 0.45⁎⁎⁎ −0.08 −0.24⁎ −0.36⁎⁎⁎ −0.41⁎⁎

−0.36⁎⁎⁎ 0.10 0.06 −0.07 −0.24⁎⁎ 0.06 0.10 −0.07 −0.19⁎ −0.06 0.28⁎⁎ 0.39⁎⁎⁎ 0.32⁎⁎

0.01 −0.25⁎⁎ 0.16 0.29⁎⁎ −0.07 −0.08 0.14 0.40⁎⁎⁎ 0.15 0.04 −0.10 −0.56⁎⁎⁎

−0.61⁎⁎⁎ −0.31⁎⁎ −0.16 −0.07 0.38⁎⁎⁎ 0.39⁎⁎⁎ −0.36⁎⁎⁎ −0.02 0.08 0.14 −0.14

Notes: N = 93. ⁎⁎⁎ p < 0.001. ⁎⁎ p < 0.01. ⁎ p < 0.05. Table 1b Field study means, standard deviations and correlations (part 2). Variable

Mean

SD

10

11

12

13

14

15

16

17

18

19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

4.94 4.92 4.33 4.73 50.25 9.23 2.88 39.84 0.32 0.44 0.17 0.05 0.01 0.33 0.43 24.43 0.11 12.20 7.21 0.70

0.63 0.78 0.73 0.68 20.99 1.36 0.24 22.40 0.47 0.50 0.38 0.23 0.10 0.20 0.24 26.66 0.31 2.04 0.70 0.45

−0.40⁎⁎⁎ −0.21⁎ −0.09 −0.13⁎ −0.40⁎⁎ −0.10 −0.17 0.04 0.09 0.25⁎⁎

−0.11 −0.05 −0.15 0.20 0.36⁎⁎⁎ 0.30⁎⁎ −0.13 −0.13 0.05

−0.02 −0.18⁎ −0.20 0.33⁎⁎ −0.08 −0.01 −0.24 −0.37⁎⁎⁎

−0.12 −0.18 0.08 −0.04 −0.03 −0.05 0.07

0.36⁎⁎⁎ −0.28⁎⁎ 0.17 0.19⁎ 0.19⁎ −0.07

−0.27⁎⁎ 0.21 0.05 0.03 −0.23⁎

0.01 −0.23⁎⁎ −0.14 −0.25⁎⁎

−0.11 −0.13 −0.00

0.37⁎⁎⁎ −0.02

0.13

ManAcc AuditRep MinIntrst CGI GovInt GDP FDI Individualism legor_uk legor_fr legor_ge legor_sc legor_so Ling-fractional Relig-fractional Latitude Landlock LnArea LnPopul pronoundrop

Notes: N = 93. ⁎⁎⁎ p < 0.001. ⁎⁎ p < 0.01. ⁎ p < 0.05.

There is support for this hypothesis in our results as shown in Model 5 (β = 0.03, p = 0.004). In Hypothesis 2, we proposed that government integrity, as a contextual leadership factor, will positively impact on auditing and accounting reports. As predicted, government integrity has a positive and significant impact on auditing and accounting reports as shown in Model 6 (β = 0.04, p = 0.003). In Hypothesis 3, we proposed that government integrity, as a contextual leadership factor, will positively impact on the protection of minority interests. As we predicted, government integrity has a positive and significant impact on the protection of minority interests as shown in Model 7 (β = 0.05, p = 0.000). In Hypothesis 4, we proposed that government integrity, as a contextual leadership factor, will positively impact on overall corporate

constraints were tenable, suggesting that the instruments are jointly exogenous.4 Our central hypothesis is that corporate leadership in a given context of government integrity will positively impact on national corporate governance practices. Compared to the OLS estimates, discussed above, coefficients from 2SLS trend in the same direction, however, they are larger. For example, in Hypothesis 1, we proposed that government integrity, as a contextual leadership factor, will positively impact on managerial accountability to shareholders and the board.

4 Note that Model 7 returns probability of 0.089. However, this suggests that test results are only marginally significant at 10% level when we use protection of minority investors as a dependent variable.

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significant coefficient as an indication of the causal effect of the context of government integrity on leaders' corporate governance practices. Another finding worth mentioning is that from one of the control variables, specifically, the economic development. This is because from 2SLS results, the impact of economic development on managerial accountability to shareholders and the board, on protection of minority investors and on the overall corporate governance index suggest that when countries are doing well economically, less attention is given to corporate governance. This probably explains why corporate governance is considered to be cyclical as calls for improved corporate governance tend to take place when performance by firms and countries is poor or following corporate scandals (Clarke, 2017).

Table 2 OLS results of the effects of government integrity on corporate governance. Model

Constant GovInt GDP FDI Individualism Adj R2 F-statistic

1

2

3

4

ManAcc

AudRep

MinIntst

4.49 (0.69) 0.02⁎⁎⁎ (0.00) −0.03⁎ (0.11) −0.21+ (0.19) 0.00 (0.00) 0.60 35.41⁎⁎⁎

3.38 (0.83) 0.02⁎⁎⁎ (0.00) 0.23⁎⁎ (0.14) −0.17 (0.23) 0.00 (0.00) 0.61 37.29⁎⁎⁎

3.20 (0.84) 0.03⁎⁎⁎ (0.00) −0.09 (0.14) 0.01 (0.24) 0.00 (0.00) 0.55 29.25⁎⁎⁎

⁎⁎⁎

⁎⁎⁎

⁎⁎⁎

CGIndex 3.69⁎⁎⁎ (0.71) 0.02⁎⁎⁎ (0.00) 0.03 (0.12) −0.12 (0.20) 0.00 (0.00) 0.64 41.29⁎⁎⁎

Laboratory study: experimental design and hypotheses Our field study suggests that, at the macro level, government integrity impacts on corporate governance decisions. Yet, further exploration is needed to clearly show the link between the macro level contextual impact of government integrity on the leader's decision making or choices at the micro level. To achieve this, we utilize the methodology of laboratory experiments. Specifically, we design a series of experimental treatments, where we vary the social norm about corporate governance (corporate governance norm variable), the level of corruption in the state (government integrity variable), the strength of law enforcement mechanisms (law enforcement variable), as well as the level of profit which could be achieved from corporate activity (profit level variable). In our design, each variable may take only 2 values, therefore, we have 16 treatment variations in total. In each variation, participants are assigned to groups of 3 people each. A randomization process assigns the CEO role to one of the participants and the roles of employees to 2 of the participants.6 Each group of participants is asked to perform a simple experimental task. In this experimental task, the group receives an endowment of £9. The CEO then has an opportunity to invest the money into a risky business activity or to keep the endowment. If the CEO decides to keep the endowment, each group participant receives £3. The group has an opportunity to earn more money if the CEO decides to invest in a risky business activity. The exact amount of money at stake is determined by the value of the profit level variable. To maximize the number of observations, we use a strategy method, asking all participants to make their decisions “as if” they played the role of the CEO. After all decisions are made, the computer program determines the CEO in each group and calculates the payoff for each player. Half of the variations (8 of 16) represent our baseline in the sense that we do not use the corporate governance norm in those variations. In the other half of variations (8 of 16), the norm (e.g., Bendahan, Zehnder, Pralong, & Antonakis, 2015) is first elicited and informed to the participants. To elicit the norm, we used the following two questions:

Notes: N = 93. Robust standard errors in parentheses. + Significant at 0.10 level. ⁎ Significant at 0.05 level. ⁎⁎ Significant at 0.01 level. ⁎⁎⁎ Significant at 0.001 level.

governance practices. As we predicted, government integrity has a positive and significant impact on corporate governance index as shown in Model 8 (β = 0.04, p = 0.001).5 Discussion of field results The results of the field study offer support to the tested hypotheses. The results suggest that countries with higher levels of government integrity, characterized by less corruption, are perceived to have better corporate governance practices. First, and specifically, we found a significant causal relationship such that higher levels of government integrity positively impact on managerial accountability to shareholders and the board. This finding points to the exemplary guidance that good national governance provides to corporate leaders either through the presence of effective formal institutions of the government (North, 1990) or simply by way of conforming to what may be seen as normal national behavior (Scott, 2001). Second, we found a significant causal relationship such that higher levels of government integrity positively impact on the strength of audit and accounting reports. This finding helps to explain the heterogeneity of auditing and accounting reporting across the world even in instances where countries adopted similar international accounting standards. Thus, while countries may be using similar accounting standards (e.g. International Accounting Standards-IAS), however, the quality of their application differs as a function of contextual factors, where government integrity is one of them. Previous studies have noted a variety of contextual factors including legal, social and economic factors and attention has not been given to the causal impact of government integrity. Third, we found a significant and causal relationship such that higher levels of government integrity positively impact on the protection of minority investors. This finding is consistent with earlier research on the determinants of minority shareholders' protection (La Porta et al., 1999). More importantly, our findings provide an explanation on the condition that allows exploitation of minority investors by majority shareholders beyond that made on emerging markets (Young et al., 2008). The three findings discussed above are summarized in our fourth hypothesis that similarly yields a positive and

(1) Do you think it is acceptable for a CEO not to pay taxes? Yes No (2) Do you think it is acceptable for a CEO to pay bribes? Yes No In each experimental session, in variations where the norm was used, participants answered these two questions and results from their responses (total percentage of “Yes” and “No” answers in an experimental session) were reported to all the participants. In other words, in these variations, we imposed a demand effect (Welsh & Ordonez, 2014) which enhanced the corporate governance norm (henceforth, the normenhancing demand effect) (e.g., Bendahan et al., 2015). This norm-

5

We conducted a robustness check to ascertain the effect of regions in our estimations. The countries in the sample were classified under the following regions: Africa, Asia, Middle East, South America, North America, Eastern Europe and Rest of Europe. Results from these tests (not included) are not significantly different from those reported in Table 3.

6 Because we are primarily interested in the link between corporate governance, government integrity and leaders' decision making, for simplicity, we concentrate on a case when leaders are appointed (exogenous assignment of CEOs) rather than voted (endogenous assignment of CEOs).

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Table 3 2SLS results of the effect of government integrity on corporate governance. Model

Constant GovInt

2

3

4

5

6

7

8

1st stage

1st stage

1st stage

1st stage

2nd stage

2nd stage

2nd stage

2nd stage

GovInt

GDP

FDI

Individual

ManAcc

AudRep

MinIntst

CGIndex

91.56⁎⁎⁎ (20.06)

5.46⁎⁎⁎ (0.56)

2.15⁎⁎⁎ (0.25)

32.71 (23.70)

9.32⁎⁎⁎ (2.92) 0.03⁎⁎ (0.01) −0.75⁎⁎ (0.27) −1.18 (0.84) 0.01 (0.01)

8.73⁎ (3.50) 0.04⁎⁎ (0.01) −0.63⁎ (0.33) −1.16 (1.01) −0.00 (0.01)

7.75⁎ (3.47) 0.05⁎⁎⁎ (0.01) −1.04⁎⁎⁎ (0.32) −0.65 (1.00) 0.00 (0.01)

8.60⁎⁎ (3.08) 0.04⁎⁎⁎ (0.01) −0.81⁎⁎ (0.29) −0.99 (0.89) 0.00 (−0.01)

0.33 5.26 p = 0.001 5.64 p = 0.582

0.37 5.27 p = 0.001 5.74 p = 0.570

0.29 6.60 p = 0.000 12.36 p = 0.089

0.36 7.08 p = 0.000 7.25 p = 0.404

GDP FDI Individualism Legor_uk Legor_fr Legor_ge Legor_sc Lingui-fractional Relig-fractional Latitude Landlock LnArea LnPopul pronoundrop R2 Hausman χ2(4)

+

11.22 (5.94) 8.97⁎ (3.56) 22.97⁎⁎⁎ (5.92) 25.94⁎⁎⁎ (7.16) −6.96 (6.92) −3.32 (9.40) 0.04 (0.11) −5.67 (4.84) −0.64 (1.89) −4.01 (4.33) −20.17⁎⁎⁎ (5.08) 0.44

0.53 (0.19) 0.52⁎⁎⁎ (0.11) 0.73⁎⁎⁎ (0.17) 0.48⁎⁎ (0.18) −0.73⁎⁎⁎ (0.21) −0.01 (0.28) 0.01⁎ (0.00) −0.19 (0.17) 0.02 (0.04) −0.26⁎ (0.11) −0.47⁎⁎ (0.15) 0.52

−0.08 (0.06) −0.013+ (0.07) −0.10 (0.06) −0.19⁎⁎ (0.06) 0.03 (0.08) −0.10 (0.09) −0.00 (0.00) −0.01 (0.06) 0.01 (0.01) 0.10⁎ (0.04) 0.12⁎⁎⁎ (0.04) 0.25

14.85 (6.17) 10.98⁎ (4.58) 11.14+ (6.38) 12.95+ (7.43) −9.91 (8.14) 9.67 (9.82) 0.29⁎ (0.12) 10.92⁎ (5.00) 2.59+ (1.47) −4.37 (3.91) −20.49⁎⁎⁎ (5.88) 0.45

18.94⁎⁎⁎

24.07⁎⁎⁎

18.85⁎⁎⁎

19.62⁎⁎⁎

⁎⁎⁎

⁎

Sargan χ2(7) F-stat (F(11, 81))

Shea's R2

1

0.154 0.285 0.087 0.270

Notes: N = 93. Robust standard errors in parentheses. + Significant at 0.10 level. ⁎ Significant at 0.05 level. ⁎⁎ Significant at 0.01 level. ⁎⁎⁎ Significant at 0.001 level.

enhancing demand effect allows us to test whether and to what extent the behavior of the study participants depends on what the social norm suggests as “acceptable” or the “right” course of action. It intends to mimic socially admissible practices, giving us an opportunity to test whether corporate decision making is affected by norms that are imposed by society. In the treatment variations with norm, in order to give participants an opportunity to express their thoughts about the social norm for corporate governance in a less structured way, we also asked them an additional question:

whether participants played in the Rich condition or in the Poor condition. In the Rich condition, investment of £9 in a risky business activity yielded £46 with a probability of 2/3 and £9 with a probability of 1/3. In the Poor condition, investment of £9 in a risky business activity yielded £19 with a probability of 2/3 and £9 with a probability of 1/3.7 In both conditions, if the group earns £9, the group payoff is reported to all participants and split equally (£3 each). In the Rich condition, if the group earns £46, the CEO has the following action space: (i) The CEO may report the entire profit to the group and pay full tax in which case: The CEO receives £40 before taxes are paid and £16 after taxes are paid (the amount of tax is £24 which is then split between the employees);

(3) Please, provide 3 keywords (adjectives) which, in your opinion, describe a “good” CEO.

•

The outcome of this question was not displayed to participants. We used participants' answers to this question to understand the commonality and divergence of views among participants about desirable CEO traits that impact on our measure of the corporate governance norm and we analyzed these answers separately. As explained above, in variations with and without the norm, we also varied the profit level variable, the law enforcement variable, and the government integrity variable. The profit level variable determined

7 Probabilities of 1/3 and 2/3 were used to minimize the effect of human probability weighting. According to Tversky and Kahneman (1992), humans tend to overestimate small probabilities and underestimate large probabilities, in other words, they have an inverse S-shaped probability weighting function. This inverse S-shaped probability weighting function crosses the 45-degree line at 1/3 (the point where probability weighting is minimal).

10

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• Employees receive £3 each before taxes are paid and £15 after

that CEOs should be honest, then they are more likely to behave honestly and if the norm suggests that it is acceptable for CEOs to be dishonest, then they are more likely to behave dishonestly.

the taxes are paid (each employee receives additional £12 of redistributed wealth). (ii) Alternatively, the CEO may report partial profit and cheat on taxes in which case: The CEO receives £40; Employees receive £3 each.

Hypothesis 6. Government integrity impacts on corporate leaders' behavior such that in a Transparent government context, CEOs are more likely to behave honestly, whereas in a Corrupt government context they are more likely to behave dishonestly.

• •

In the Poor condition, if the group earns £19, the CEO has the following action space:

Hypothesis 7. Law enforcement impacts on corporate leaders' behavior such that in a High law enforcement context, CEOs are more likely to behave honestly, whereas in a Low law enforcement context they are more likely to behave dishonestly.

(i) The CEO may report the entire profit to the group and pay full tax in which case: The CEO receives £13 before taxes are paid and £7 after taxes are paid (the amount of tax is £6 which is then split between the employees); Employees receive £3 each before taxes are paid and £6 after taxes are paid (each employee receives additional £3 of redistributed wealth). (ii) Report partial profit and cheat on taxes in which case: The CEO receives £13; Employees receive £3 each.

•

Hypothesis 8. The size of corporate profits impacts on corporate leaders' behavior such that in a Poor condition, CEOs are more likely to behave honestly, while in a Rich condition they are more likely to behave dishonestly.

•

Experimental results

• •

As explained above, we conducted 16 variations of the experiment (summarized in Fig. 1). Overall, 576 individuals took part in our experiment: 36 people (2 sessions 18 people each) participated in each experimental treatment variation. All experimental participants were students at the University of Warwick. Participants of all races, ethnic origins, genders, ages, income groups and different university majors were invited to take part in the experiment. Overall, of 576 participants, 47% were female and 53% were male. Across all variations, the percentage of female participants ranged between 42% and 55% (Kruskal-Wallis equality-of-populations test revealed no statistically significant difference across variations according to the gender composition (χ2 = 3.44, p = 0.99, df10 = 15). The average age of participants was 21 years and the standard deviation is 1.07 (Kruskal-Wallis equality-of-populations test revealed no statistically significant difference across variations according to the age composition (χ2 = 10.38, p = 0.80, df = 15). Experiments were conducted in the laboratory using the z-Tree software (Fischbacher, 2007). Slightly over 1/2 of participants (54%) were native speakers of English. The number of native speakers was similar across all 16 variations (Kruskal-Wallis test χ2 = 7.58, p = 0.94, df = 15). Irrespective of the context, in all the 8 variations where we used the norm-enhancing demand effect, over 94% of participants (on average, 98% across all 8 variations) said that it was not acceptable for the CEO to evade taxes (results of the Kruskal-Wallis test of the equity of populations suggests that there is no statistical difference across 8 variations with the norm-enhancing demand effect according to this variable (Kruskal-Wallis test χ2 = 6.29, p = 0.51, df = 7) and over 97% of participants (on average, 99% across 8 variations) said that it was not acceptable to pay bribes (results of the Kruskal-Wallis test also did not reveal statistically significant differences across treatments χ2 = 6.02, p = 0.54, df = 7). In other words, in all the 8 variations with the normenhancing demand effect, the corporate governance norm communicated to all participants was that the majority of participants believed that it was not acceptable for the CEO not to pay taxes and that it was not acceptable for the CEO to pay bribes. Therefore, in each variation with the norm-enhancing demand effect, participants received a nudge which suggested that leaders' integrity is important and that leaders should behave honestly. To explore the impact of this norm on leaders' decision making in our experiment, we calculated the total number of times when CEOs decided to hide the profit and evade taxes across all 16 treatment variations. In other words, we calculated the number of times when CEOs “cheated” or decided to behave dishonestly. Results of these

For simplicity, we assume that the CEO can either be completely honest or completely dishonest, a condition for our integrity task described above. Therefore, in both the Rich condition and the Poor condition, the CEO can either behave honestly (by selecting options (i) or dishonestly (by choosing options (ii)). In other words, our experimental task closely mimics a corporate responsibility dilemma in which a CEO can either pay or evade taxes and, in some experimental variations, can either pay on not pay bribes. A law enforcement mechanism is tested using two conditions: Low enforcement and High enforcement. In the Low enforcement condition, the integrity of the CEO is controlled 1/3 of the time, while in the High enforcement condition, the integrity of the CEO is controlled 2/3 of the time.8 When the integrity of the CEO is controlled, the CEO is fined his or her entire payoff if he or she behaves dishonestly, in which case the payoff of the CEO is divided equally between the remaining two participants in the group. There is no implication from law enforcement when the CEO behaves honestly. The level of government integrity is tested using two conditions: Corrupt government and Transparent government. If the government is Transparent, then the law enforcement mechanism is applied as described above. If the government is corrupt, the CEO has an opportunity to completely avoid controls (checks) if he or she pays ¼ of his or her payoff as a bribe (£10 in the Rich condition and £3 in the Poor condition9). We assume that if the CEO decides to hide the profit and pay the bribe, he or she would not be checked and would avoid the fine with a probability of 100%. Yet, in this case, in the Rich condition the CEO will receive £30 and in the Poor condition, the CEO will receive £10. Because in the experimental task only 2 out of 3 situations could result in a higher outcome of the investment for the group and lead to “dishonest” behavior or “cheating” (i.e., in our design, tax evasion), we used the strategy method (e.g., Fischbacher, Gächter, & Quercia, 2012) to elicit decision reactions of the CEOs and then applied those decisions when randomization procedure selected the higher outcome of the two with a probability of 2/3. Our experimental design allows us to test the following hypotheses: Hypothesis 5. The endogenous social corporate governance norm impacts on corporate leaders' behavior such that if the norm suggests 8 As explained above, we use probabilities of 1/3 and 2/3 to avoid potential effects of probability weighting (see Tversky & Kahneman, 1992). 9 In the Poor condition, ¼ of the dishonest CEO payoff is equal to £13/ 4 = £3.25. For simplicity, we round this amount to £3.

10

11

df stands for degrees of freedom.

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Fig. 1. Experimental treatment variations. Notes: No norm = demand effect enhancing endogenous social norm was not used; Norm = demand effect enhancing endogenous social norm was used.

calculations are presented in Fig. 2. As pointed out earlier, in our experiment, “cheating” refers to the decision to hide part of a CEO's payoff and evade taxes, which could be observed in all treatment variations. Decisions to resort to bribery are considered separately for variations where the government integrity is set to be low (Corrupt government conditions). As all participants decided to invest in a risky business activity rather than share the £9 equally among all group members, when we asked them to make decisions as if they were CEOs using the strategy method, we had 36 observations in each experimental variation. Each bar in Fig. 2 presents the frequency of cheating (number of times when CEOs decided to cheat relative to the total number of decisions made) in a particular variation of the experiment. According to Fig. 2, the corporate governance norm is correlated with leaders' propensity to behave honestly. In all variations with the norm-enhancing demand effect, the norm was “positive” in the sense that the overwhelming majority of participants believed that the integrity of CEOs' was important and that CEOs should behave honestly. We, therefore, did not have an opportunity to test the reverse norm.

Fig. 2 shows that in variations with the norm-enhancing demand effect cheating is a lot less frequent than in variations without the normenhancing demand effect. Specifically, in variations without the normenhancing demand effect, 95 out of 288 decisions (33%) were dishonest, whereas in variations with the norm-enhancing demand effect, only 56 out of 288 decisions (19%) were dishonest. The difference between these two conditions is highly statistically significant (Fisher's exact test p = 0.001). Government integrity is also a significant determinant of leaders' decision making. Specifically, in variations with a Transparent government, 34 of 288 (12%) of decisions are dishonest, while in variations with a Corrupt government, 117 of 288 (41%) of decisions are dishonest. The difference between decisions made in Transparent conditions and those made in Corrupt conditions is highly statistically significant (Fisher's exact test p = 0.001). In our experiment, CEOs tend to cheat more in Low enforcement (105 of 288 cases, 36%) than in High enforcement variations (46 of 288 cases, 16%). This difference is highly statistically significant (Fisher's exact test p = 0.001). They also cheat more in variations with Rich (96 12

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Rich Transparent

Poor Corrupt

Poor Transparent

LOW ENFORCEMENT

LOW ENFORCEMENT

0.03

0.11

0.08

HIGH ENFORCEMENT

NO NORM

0.08

0.22

0.17 0.06

0.11

0.14

0.22

0.25

0.33

0.44

0.53

0.58

0.83

Rich Corrupt

HIGH ENFORCEMENT

NORM

Fig. 2. Experimental Summary statistics: cheating frequency by treatment variation. Notes: Cheating frequency is shown on the vertical axis. No norm = demand effect enhancing endogenous social norm was not used; Norm = demand effect enhancing endogenous social norm was used.

of 288 cases, 33%) rather than Poor (55 of 288 cases, 19%) incentive conditions (Fisher's exact test p = 0.001). At first sight, it may seem that Hypotheses 5–8 are confirmed, however, the picture is different when comparisons of individual variations are made. We first consider experimental variations where all treatment variables, apart from the norm, are held the same. Specifically, in the Rich, Corrupt government, Low enforcement conditions, the variation with norm has a count of 30 (83%) dishonest decisions, whereas in the variation without the norm the count is 19 (53%). This difference is significant according to the Fisher's exact test (p = 0.005). Similar results are observed for Rich, Corrupt government, High enforcement conditions, where the cheating count is 16 (44%) for “No norm” variation and 8 (22%) for the “With Norm” variation (Fisher's exact test, p = 0.040). This result is also observed in variations with Poor, Corrupt government conditions. Specifically, cheating is more prevalent in Poor, Corrupt government, Low enforcement variation without the norm-enhancing demand effect (21 cases of cheating, 58%), than in Poor, Corrupt government, Low enforcement variation with the norm-enhancing demand effect (12 cases of cheating, 33%). This difference is statistically significant (Fisher's exact test, p = 0.029). In the variation with Poor, Corrupt government, High enforcement and without the norm-enhancing demand effect, CEOs cheated 8 times (22%); whereas in the variation with Poor, Corrupt government, High enforcement and the norm-enhancing demand effect, CEOs cheated only 3 times (8%). This difference is marginally statistically significant11 (Fisher's exact test, p = 0.094). While the difference between “No norm” and “With norm” conditions is statistically significant in all treatment variations with a Corrupt government, when we consider variations with a Transparent government, we do not observe results that are statistically significant. Specifically, in Rich, Transparent government, Low enforcement variations without the norm-enhancing demand effect (9 cheating cases,

11

25%) and with the norm-enhancing demand effect (6 cheating cases, 17%) the difference in CEO behavior is not statistically significant (Fisher's exact test = 0.280). In Rich, Transparent government, High enforcement variation without the norm-enhancing demand effect, CEOs tend to cheat exactly the same number of times (4 cases, 11%) as in Rich, Transparent government, High enforcement variation with the norm-enhancing demand effect (4 cases, 11%). Similarly, in Poor, Transparent government, Low enforcement variations without (5 cases, 14%) and with (3 cases, 8%) the norm-enhancing demand effect the frequency of cheating is very similar (Fisher's exact test = 0.36). We obtain the same result in Poor, Transparent government, High enforcement variations without (2 cases, 5%) and with (1 case, 3%) the norm-enhancing demand effect (Fisher's exact test, p = 0.500). Therefore, Hypothesis 5 is only partially confirmed as social norm about corporate governance is an important determinant of leaders' decisions only in variations with a Corrupt government condition (in variations with the norm-enhancing demand effect cheating frequency is lower than that in variations without the norm-enhancing demand effect), whereas in variations with a Transparent government condition the level of cheating is low in all variations and the impact of the normenhancing demand effect is not statistically significant. Similar results are obtained for Low and High enforcement conditions. When government integrity is low (Corrupt government), cheating is observed more frequently in the Low enforcement condition rather than High enforcement condition. Yet, when the government is Transparent, the level of cheating is low in all variations. Specifically, in Rich, No norm variations and when the government is Corrupt, High enforcement (30 cases, 83%) is associated with lower frequency of cheating than Low enforcement (16 cases, 44%). Similarly, in Rich, With norm variations when the government is Corrupt, High enforcement (8 cases, 22%) is associated with lower frequency of cheating than Low enforcement (19 cases, 53%). Results of Fisher's exact test show high statistical significance in variations without (p = 0.001) and with (p = 0.007) the norm-enhancing demand effect. In Poor, Corrupt, No norm variations, CEOs cheat less in High enforcement (8 cases, 22%)

It is significant at 10% rather than 5% level. 13

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Table 4 Mean values and correlation matrix for experimental variables presented in Tables 5a–5c.

Norm Enforcement Rich-Poor Corruption Gender Age Native speaker Income Experience Major

Mean

SD

Norm

Enforcement

Rich-Poor

Corruption

Gender

Age

0.50 0.50 0.50 0.50 0.47 21.04 0.54 1.53 0.80 0.54

0.50 0.50 0.50 0.50 0.50 1.07 0.50 1.42 0.71 0.50

1 0 0 0 −0.02 0.10 0.02 0.06 −0.04 −0.03

1 0 0 0.00 0.01 −0.00 −0.08 0.01 −0.03

1 0 0.00 0.01 −0.04 0.01 0.06 0.02

1 −0.04 0.00 0.03 0.09⁎ 0.02 −0.00

1 0.05 −0.01 −0.06 0.02 −0.00

1 −0.07 0.03 0.04 0.04

Native speaker

Experience

Major

1 −0.02 0.00 0.04

1 −0.04 0.00

1 −0.03

Notes: Norm (Norm = 1; No norm = 0); Enforcement (High = 1, Low = 0); Rich-Poor (Rich = 1, Poor = 0); Corruption (Corrupt state = 1; Transparent state = 0); Gender (Female = 1; Male = 0); Age (age in years); Native speaker dummy (1 = native speaker of English, 0 = otherwise); Income (the higher, the more the annual income is); Experience (the higher the more experience participants have in taking part in experiments); Major (Economics or Business = 1, Other = 0). ⁎ Significant at 0.05 level.

that government integrity is the most important determinant of the propensity to cheat among CEOs in our experiment. Recall that in 8 out of 16 variations, government integrity is low (Corrupt condition) and CEOs may avoid checks by paying a bribe. Table 6 provides summary statistics on the frequency of bribes in each variation with a Corrupt government condition. Table 6 shows that the effect of the corporate governance norm goes in the same direction for the effect for bribing decisions and for cheating decisions. Specifically, in the No Norm variations, overall, CEOs resort to bribing in 50 out of 75 cases, whereas in Norm variations they use bribing in 26 out of 42 cases. We conducted a clustered12 probit regression, with bribery as a dependent variable and treatment variables (corporate governance norm, enforcement mechanism, and Rich-Poor revenue size). Even though the sample size for bribing decisions is relatively small (there are 117 observations from the Corrupt government variations when CEOs cheated and, therefore, had an opportunity to resort to bribing), we found that the only significant treatment variable is Rich-Poor condition. Specifically, bribery was more common in the Rich rather than in the Poor condition (coefficient β = 0.33; robust SE = 0.17, z statistic = 1.95, and p = 0.051). Other treatment variables are not statistically significant for bribing decisions. Additionally, we also analyzed text data from question (3) about the desirable characteristics of the CEO in order to better understand the corporate governance norm. The analysis of textual information provided by the participants reveals that credible, sincere, and truthful are among the most common characteristics of a “good” CEO as described by the experimental participants. Fig. 3 presents the word cloud analysis mapping characteristics which were mentioned twice or more by participants. The larger the font of the trait, the more it was mentioned by participants. Overall, Fig. 3 shows that characteristics associated with integrity are very common. Specifically, participants mentioned “credible” 53 times (most frequent), sincere – 41 times, reliable – 30 times, and truthful – 25 times.

variation compared to the Low enforcement (21 cases, 58%) variation (Fisher's exact test = 0.002). Similarly, in Poor, Corrupt, With norm variations, CEOs cheat less in High enforcement (3 cases, 8%) variation than in the Low enforcement (12 cases, 33%) variation (Fisher's exact test, p = 0.009). However, when the state is Transparent, differences between Low and High enforcement are not statistically significant. In these conditions, CEOs in Rich, No Norm variations resort to cheating less in High enforcement (4 cases, 11%) compared to Low enforcement (9 cases, 25%) variations. However, this difference is not statistically significant (Fisher's exact test p = 0.110). A similar result is obtained for the variations With Norm where the frequency of cheating is 17% (6 cases) in the Low enforcement condition and 11% (4 cases) in the High enforcement condition (Fisher's exact test p = 0.37). In variations with Transparent government, No norm, Poor variations, CEOs cheat in 5 (14%) and 2 (5%) cases in Low and High enforcement, respectively (Fisher's exact test p = 0.21). In variations with a Transparent government, With norm, Poor variations, CEOs cheat in 3 (8%) and 1 (3%) cases in Low and High enforcement, respectively (Fisher's exact test p = 0.31). Therefore, Hypothesis 7 is only partially confirmed as the enforcement mechanism matters only in variations with a Corrupt government. Overall, our findings suggest that government integrity is a very important determinant of CEO decisions. The effects associated with corporate governance norms and enforcement mechanisms are a lot stronger in variations with a Corrupt government compared to one with a Transparent government. Table 4 provides correlation analysis and Tables 5a–5c reports a series of comparisons between variations with a Corrupt and a Transparent government. Interestingly, in all comparisons, with the only exception of high enforcement variations with the norm-enhancing demand effect (Fisher exact test probabilities for all comparisons are > 0.1), cheating is more frequent in a Corrupt government condition than in a Transparent government condition (Fisher exact test probabilities for all comparisons are lower than 0.05). Fig. 2 also shows that the lowest frequency of cheating is associated with a Transparent government, High enforcement variation with the norm-enhancing demand effect. The highest level of cheating is associated with No norm, Corrupt government, Low enforcement variation. We also conduct a series of OLS and probit regressions (unclustered as well as clustered by experimental variation). Results of these regressions are reported in Tables 5a–5c. Tables 5a–5c show that the norm-enhancing demand effect and high enforcement are associated with lower cheating propensity, whereas low government integrity (Corrupt government) as well as high business profit (Rich condition) are associated with a high frequency of cheating. None of the personal characteristics have a significant effect on CEOs decisions. Importantly, the regression coefficients for government integrity are higher than the regression coefficients for any other treatment variables, confirming

Discussion of laboratory results Our experimental results confirm the link between corporate governance, decision making by leaders and government integrity. In fact, results from a series of Fisher's exact tests suggest that government integrity is a better determinant of how leaders make decisions and choices than corporate governance norms and enforcement mechanisms. Specifically, making social norms more transparent, through creating a demand effect, potentially leads to higher corporate 12 Observations were clustered by experimental treatment variation (8 variations where Corrupt government condition was implemented).

14

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Table 5a Results of the OLS and probit regressions using all experimental data. Dependent variable is “Cheating” (1 = decision to hide profit by the CEO; 0 - otherwise). Independent variable

OLS

Probit

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.14⁎⁎⁎ (0.03) −0.20⁎⁎⁎ (0.03) 0.14⁎⁎⁎ (0.03) 0.29⁎⁎⁎ (0.03) –

–

−0.13⁎⁎⁎ (0.03) −0.20⁎⁎⁎ (0.03) 0.14⁎⁎⁎ (0.03) 0.29⁎⁎⁎ (0.03) −0.04 (0.03) −0.02 (0.02) 0.02 (0.03) −0.00 (0.01) 0.01 (0.02) 0.03 (0.03) –

0.22 (0.04) 576 0.21

0.69 (0.33) 576 0.22

Norm (Norm = 1; No norm = 0) Enforcement (High = 1, Low = 0) Rich-Poor (Rich = 1, Poor = 0) Corruption (Corrupt state = 1; Transparent state = 0) Gender (Female = 1; Male = 0) Age (age in years)

–

Native speaker dummy (1 = native speaker of English, 0 = otherwise) Income (the higher, the more the annual income is)

– –

Experience (the higher the more experience participants have in taking part in experiments) Major (Economics or Business = 1, Other = 0)

– –

Clustered by Constant

⁎⁎⁎

Number of observations R2 for OLS/pseudo R2 for probit

Model 3 Coefficient (robust SE)

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.50⁎⁎⁎ (0.13) −0.76⁎⁎⁎ (0.13) 0.55⁎⁎⁎ (0.13) 1.05⁎⁎⁎ (0.13) –

–

−0.50⁎⁎⁎ (0.13) −0.76⁎⁎⁎ (0.13) 0.56⁎⁎⁎ (0.13) 1.06⁎⁎⁎ (0.13) −0.12 (0.13) −0.11 (0.06) 0.09 (0.13) 0.00 (0.04) 0.01 (0.09) 0.12 (0.13) –

−0.96 (0.14) 576 0.20

1.15 (1.21) 576 0.21

−0.13⁎⁎⁎ (0.03) −0.20⁎⁎⁎ (0.03) 0.14⁎⁎⁎ (0.03) 0.29⁎⁎⁎ (0.04) −0.04 (0.04) −0.02 (0.01) 0.02 (0.03) −0.00 (0.01) 0.01 (0.02) 0.03 (0.03) 32 experimental sessions 0.69 (0.30) 576 0.22

– – – – –

⁎⁎⁎

Model 3 Coefficient (robust SE) −0.50⁎⁎⁎ (0.09) −0.76⁎⁎⁎ (0.08) 0.56⁎⁎⁎ (0.08) 1.06⁎⁎⁎ (0.10) −0.12 (0.15) −0.11 (0.05) 0.09 (0.14) 0.00 (0.05) 0.01 (0.09) 0.12 (0.13) 32 experimental sessions 1.15 (1.11) 576 0.21

Notes: No norm = demand effect enhancing endogenous social norm was not used; Norm = demand effect enhancing endogenous social norm was used. ⁎⁎⁎ Significant at 0.001 level.

Table 5b Results of the OLS and probit regressions using data without the norm-enforcing demand effect. Dependent variable is “Cheating” (1 = decision to hide profit by the CEO; 0 - otherwise). Independent variable

Enforcement (High = 1, Low = 0)

OLS

Probit

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.24⁎⁎⁎ (0.05) 0.16⁎⁎⁎ (0.05) 0.38⁎⁎⁎ (0.05) –

Experience (the higher the more experience participants have in taking part in experiments) Major (Economics or Business = 1, Other = 0)

–

Clustered by

–

−0.24⁎⁎⁎ (0.05) 0.16⁎⁎⁎ (0.05) 0.38⁎⁎⁎ (0.05) −0.08 (0.05) −0.01 (0.02) 0.06 (0.04) −0.01 (0.01) 0.01 (0.03) 0.01 (0.05) –

0.18⁎⁎⁎ (0.05) 288 0.26

0.37 (0.47) 288 0.27

Rich-Poor (Rich = 1, Poor = 0) Corruption (Corrupt state = 1; Transparent state = 0) Gender (Female = 1; Male = 0) Age (age in years)

–

Native speaker dummy (1 = native speaker of English, 0 = otherwise) Income (the higher, the more the annual income is)

–

Constant Number of observations R2 for OLS/pseudo R2 for probit

–

–

Model 3 Coefficient (robust SE) −0.24⁎⁎⁎ (0.04) 0.16⁎⁎⁎ (0.04) 0.38⁎⁎⁎ (0.05) −0.08 (0.05) −0.01 (0.02) 0.06 (0.05) −0.01 (0.01) 0.01 (0.04) 0.01 (0.04) 16 experimental sessions 0.37 (0.43) 288 0.27

Notes: In this analysis only data from sessions without the demand effect were used (No norm variations). ⁎⁎⁎ Significant at 0.001 level.

15

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.84⁎⁎⁎ (0.18) 0.57⁎⁎⁎ (0.17) 1.26⁎⁎⁎ (0.18) –

–

−0.84⁎⁎⁎ (0.18) 0.58⁎⁎⁎ (0.18) 1.28⁎⁎⁎ (0.18) −0.25 (0.17) −0.05 (0.08) 0.21 (0.18) −0.01 (0.06) 0.04 (0.12) 0.01 (0.18) –

−1.07⁎⁎⁎ (0.18) 288 0.22

−0.16 (1.65) 288 0.24

– – – – –

Model 3 Coefficient (robust SE) −0.84⁎⁎⁎ (0.09) 0.58⁎⁎⁎ (0.11) 1.28⁎⁎⁎ (0.12) −0.25 (0.19) −0.05 (0.08) 0.21 (0.19) −0.01 (0.07) 0.04 (0.15) 0.01 (0.13) 16 experimental sessions −0.15 (1.55) 288 0.24

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Table 5c Results of the OLS and probit regressions using data with the norm-enforcing demand effect. Dependent variable is “Cheating” (1 = decision to hide profit by the CEO; 0 - otherwise). Independent variable

OLS

Probit

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.17⁎⁎⁎ (0.04) 0.13⁎⁎ (0.04) 0.19⁎⁎⁎ (0.04) –

Enforcement (High = 1, Low = 0)

Experience (the higher the more experience participants have in taking part in experiments) Major (Economics or Business = 1, Other = 0)

–

Clustered by

–

−0.16⁎⁎⁎ (0.04) 0.12⁎⁎ (0.04) 0.19⁎⁎⁎ (0.04) −0.00 (0.04) −0.04 (0.02) 0.00 (0.04) 0.00 (0.02) 0.00 (0.03) 0.04 (0.04) –

012⁎⁎ (0.04) 288 0.13

0.94⁎ (0.46) 288 0.14

Rich-Poor (Rich = 1, Poor = 0) Corruption (Corrupt state = 1; Transparent state = 0) Gender (Female = 1; Male = 0) Age (age in years)

–

Native speaker dummy (1 = native speaker of English, 0 = otherwise) Income (the higher, the more the annual income is)

–

Constant Number of observations R2 for OLS/pseudo R2 for probit

–

–

Model 3 Coefficient (robust SE) −0.16⁎⁎⁎ (0.03) 0.12⁎⁎ (0.03) 0.19⁎⁎⁎ (0.04) −0.00 (0.04) −0.04 (0.02) 0.00 (0.02) −0.01 (0.01) 0.00 (0.02) 0.04 (0.05) 16 experimental sessions 0.94⁎ (0.43) 288 0.14

Model 1 Coefficient (SE)

Model 2 Coefficient (SE)

−0.69⁎⁎⁎ (0.19) 0.54⁎⁎ (0.19) 0.80⁎⁎⁎ (0.19) –

–

−0.70⁎⁎⁎ (0.19) 0.56⁎⁎ (0.19) 0.81⁎⁎⁎ (0.20) −0.03 (0.19) −0.17 (0.09) 0.03 (0.19) 0.03 (0.07) −0.02 (0.14) 0.17 (0.19) –

−1.33⁎⁎⁎ (0.20) 288 0.14

2.16 (1.85) 288 0.16

– – – – –

Model 3 Coefficient (robust SE) −0.70⁎⁎⁎ (0.09) 0.53⁎⁎⁎ (0.10) 0.81⁎⁎⁎ (0.15) −0.03 (0.24) −0.17 (0.08) 0.03 (0.20) 0.03 (0.06) −0.01 (0.09) 0.17 (0.23) 16 experimental sessions 2.16 (1.56) 288 0.16

Notes: In this analysis only data from sessions with the demand effect were used (Norm variations). ⁎⁎⁎ Significant at 0.001 level. ⁎⁎ Significant at 0.01 level.

governance norms may offer a better way to make leaders' decisions more honest.

Table 6 Experimental summary statistics: Bribery frequency in Corrupt condition.

No norm

Low enforcement High enforcement

Norm

Low enforcement High enforcement

Rich

Poor

20 of 30 (67%) 12 of 16 (75%) 14 of 19 (74%) 5 of 8 (63%)

11 of 21 (52%) 7 of 8 (88%) 6 of 12 (50%) 1 of 3 (33%)

General discussion A central argument in this study is that leadership is embedded in the context (Johns, 2006). As such leaders' choices and actions are influenced and shaped by institutions that define the context (Oc, 2018). Drawing on the arguments and literatures on leadership and integrity, we thus sought to establish the relationship between government integrity and the effectiveness of certain corporate governance practices across countries. The assumption is that corporate governance practices are the result of corporate leaders' choices pursuant of the situational or contextual factors, including the level of corruption in their countries. Using the two-stage least squares method, a statistical technique that takes care of endogeneity in econometric models, the field study provides externally valid evidence that government integrity determines the extent to which certain corporate governance practices are applied. The experimental study, focusing on the individual leader, supports the overarching finding in the first study, imposing more structure and providing clarity on the leaders' decision-making mechanisms under conditions of varying, endogenous, and contextual norms. Indeed, results from the experimental study show that CEOs are more likely to cheat in a corrupt environment than in a transparent one. Beyond the use of an appropriate statistical approach in 2SLS, alongside an experimental study, this paper contributes to the literature on contextual leadership, providing better understanding of the link between government integrity and corporate governance practices. Indeed, by bringing together literatures on government integrity, a domain of political and policy studies, and corporate governance, a domain of management and accounting and finance, this study provides a multidisciplinary view of contextual leadership. Moreover, findings from this study provide answers to some of the

Notes: Bribery is only possible in the Corrupt condition. No norm = demand effect enhancing endogenous social norm was not used; Norm = demand effect enhancing endogenous social norm was used.

responsibility in a Corrupt government condition, whereas in a Transparent government condition the level of tax evasion is low irrespective of norm, enforcement strength as well as other contextual variables (e.g., Rich versus Poor condition in terms of the payoff size). Perhaps the most interesting result of our experiment is the impact of the social norm of corporate governance in a Corrupt government condition. This result suggests that making a “positive” social norm transparent increases CEO integrity. In other words, a simple reminder about social norms in corrupt environments might make a lot of positive difference, encouraging more responsible corporate behavior. This result is particularly important because, in practice, many states spend large amounts of money on developing anti-corruption measures. These measures often take the form of either a carrot (e.g., increasing size of salaries of decision makers in order to discourage tax evasion and bribery) or a stick (e.g., increasing punishment for those who engage in tax evasion and bribery). Our experimental findings show that such carrot-and-stick measures may not help improve leaders' integrity. In fact, campaigns which communicate positive social corporate 16

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Fig. 3. A word cloud analysis of the “good” CEO traits. Notes: most commonly mentioned characteristics of “good” CEO are shown in bolder and larger font.

higher in countries with low levels of government integrity. In such countries, companies may need to incur more agency costs by appointing more independent directors and making use of well-designed managerial incentives that help align the interests of management with those of shareholders (Shleifer & Wolfenzon, 2002).

questions that have dominated the corporate governance literature for some time. For example, some studies have attributed the failure or success of corporate leadership to firm and CEO characteristics (Hambrick & Mason, 1984) as well as a range of corporate governance mechanisms, without taking into consideration the effect of government integrity that vary across countries, on corporate leadership. As such, our study expands understanding of how governments differ and how they matter in the leadership of firms. Essentially, the study highlights the effect of corruption on corporate leadership. In instances where cross-country studies have been carried out, the focus has been on the variety of corporate governance models (Aguilera & Jackson, 2003), with emphasis on the respective effectiveness of such models (Hansmann & Kraakman, 2001; Yoshikawa & Rasheed, 2009). In such studies, scholars have often attributed the failure of corporate governance systems to the quality of the institutional environment such as the country's laws and regulations, without going beyond the level of policy implementation to examine why such institutions are effective in some countries and not in others. By arguing for government integrity, a hypothesis confirmed by our findings from both field and experimental studies, this research provides an important determinant to, and indeed a potential element that leads to heterogeneity in, the success of corporate governance practices across countries. Indeed, our study, through a combination of field and experimental studies, not only provides a comprehensive analysis of corporate decision making observed at the national level, but shows too the behavior of the individual leader under different contextual and norm conditions. In addition, our study has implications for investors. For example, using knowledge of a country's level of government integrity, minority investors may be able to determine the probability of exploitation they are likely to suffer from majority shareholders or from self-interested executives (Fama & Jensen, 1983). In cases where government integrity is low, minority investors may have to consider mechanisms that allow their voices to be heard either by pooling their resources together, engaging more with legal advisors or making use of proxy voting. Moreover, investors, in general, may need to take more attention on how CEOs make decisions and how firms report their financial reports in countries that have low levels of government integrity and low levels of enforcement. Finally, the fact that managerial accountability to both shareholders and the board is better in countries with higher levels of government integrity has implications for corporate governance practice. The logic of this observation is that the need for monitoring should, therefore, be

Limitations and the possibility for further research Notwithstanding the relevance and timeliness of this study, we identify some limitations and suggest avenues for further research. Although, we believe that we have captured some of the key variables in corporate governance, future studies could test the effect of government integrity on other governance variables such as the use of board committees, independent directors and the emerging theme of board diversity. Such studies could use interviews to gather more and direct information on corporate leaders' decision-making mechanisms across countries with varying levels of government integrity. Moreover, studies could focus on the behavior and decision-making mechanisms of CEOs in several countries with varying approaches on anti-corruption practices. We also acknowledge that the survey items we used for our dependent variables were not worded to directly source information on company practices but on national business norms. However, the use of the laboratory experiment made up for this potential weakness. Conclusion The present study finds that government integrity has a positive effect on corporate governance practices and choices made by corporate leaders. Beyond the question of corporate governance choices made by corporate leaders, this study has unveiled what appears to be weaknesses on current anti-corruption practices within the business environment. Consequently, two important lessons are discernible from this study. First, from the field study, our findings demonstrate that governments need to get it right first before expecting corporate citizenry to do the right thing. Second, from the experimental study, it is clear that in contexts where government integrity is low, the nature of the problem lies at the heart of what is right, ethical and acceptable, on the one hand; and what is mandated by the law, on the other. This gap may be bridged by instilling acceptable social norms in corporate leaders. According to Axelrod (1986), a norm exists in a given social setting to the extent that individuals usually act in a certain way and are often 17

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punished when seen not to be acting this way. The problem, of course, is that in contexts characterized with high levels of corruption pervasiveness (Rodriguez et al., 2005) there may not be norms to talk about as irresponsible actions go unpunished. This raises the question of the origin of norms or put differently, what is the content of behavior that might later turn into a norm? Moreover, how can norms be sustained and maintained? An evolutionary approach to norms (Axelrod, 1986) suggests that norms, that are often a reflection of underlying interests and resulting political struggles in a society, originate from the dominant actors in society who have the power, through punishments, to promote a certain type of behavior. As such, norms often precede laws but are then supported, maintained and extended by laws (Miyashita, 2007). Therefore, to the extent that those with power to change societal norms do not have the interest or motive to do so, contexts that lack government integrity may be difficult to change with the effect that corporate leaders may continue to make bad corporate governance choices and decisions.

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