Can a Code of Ethics Improve Manager Behavior and Investor Confidence? An Experimental Study

Policy makers and corporations have recently emphasized a code of ethics as an effective aspect of corporate governance. The corporate governance literature in accounting, however, provides little empirical or theoretical support for this emphasis. We address this gap between public policy and the literature by studying the effectiveness of a code of ethics in an experimental setting. Using Bicchieri’s (2006) model of social norm activation, we predict that a code of ethics will improve manager return behavior and investor confidence to the extent that it activates social norms that control opportunistic behavior. Further, we predict that adding a certification choice whereby the manager can publicly certify that he will adhere to the code will enhance the potential for the code of ethics to activate such norms. We find that a code of ethics only improves manager return behavior and investor confidence when the code incorporates a public certification choice by the manager. When the code is present but there is no certification choice, manager return behavior does not improve and investor confidence erodes over time because of increased expectations that are not met by managers. An analysis of individual return decisions and exit questionnaire responses supports the activation of social norms as the underlying mechanism behind our results.