From JPMorgan Chase to Tesla, whistleblowers have become a major force in corporate accountability, exposing issues ranging from misleading disclosures to safety concerns. Regulators have reinforced that role by offering substantial financial incentives, with the U.S. Securities and Exchange Commission awarding whistleblower payouts worth as much as $20 million.

The logic behind those rewards seems straightforward: Larger payouts should encourage more people to report wrongdoing. But new research by Ronghuo Zheng, associate professor of accounting at McCombs School of Business, suggests the relationship is more complicated. Working with Lin Nan of Purdue University, Zheng argues that whistleblower incentives operate within a “Goldilocks” range — too little discourages reporting, but too much may also create unintended consequences.

According to the researchers, excessively large rewards can actually reduce whistleblowing. Their theoretical economic model shows that when incentives become too strong, managers may become reluctant to share sensitive information with employees who could later report problems to regulators. “If the whistleblowing incentive is too strong, it can potentially backfire,” Zheng says.

The dynamic begins when managers uncover defects such as regulatory violations or safety flaws. Under moderate incentive levels, managers still share information internally, allowing employees either to fix the issue or, in some cases, report misconduct externally. But when whistleblower rewards become especially lucrative, employees may be more likely to report issues rather than resolve them internally. Anticipating that possibility, managers may respond by restricting the flow of information altogether.

Zheng points to Theranos as a real-world example of the dangers linked to limited information-sharing. Founder Elizabeth Holmes tightly controlled access to information about the company’s faulty blood-testing technology, making it difficult for employees to understand the scope of the problems fully. The devices later proved unreliable, contributing to patient misdiagnoses, the collapse of the company, and criminal convictions for Holmes and another founder.

Although the study is theoretical rather than based on real-world data, Zheng says the findings carry important implications for regulators such as the SEC. Rather than continually increasing whistleblower payouts, the research suggests incentives should be calibrated carefully — strong enough to encourage reporting, but not so aggressive that they discourage internal communication and prevent problems from being identified and resolved before they escalate into larger crises.

More information: Lin Nan et al, Whistleblowing and Internal Communication, The Accounting Review. DOI: 10.2308/TAR-2024-0036

Journal information: The Accounting Review Provided by University of Texas at Austin