Internal Controls Placebos

Does a placebo effect apply to internal controls?

A placebo is a substance or procedure which a patient accepts as a medicine or therapy but which has no specific therapeutic activity for the condition. Any effect is thought to be based on the power of suggestion.

A placebo effect occurs when a patient's symptoms are altered in some way (i.e., alleviated or exacerbated) by a treatment, due to the individual expecting or believing that it will work.

The placebo effect occurs when a patient is treated in conjunction with the suggestion from an authority figure or from acquired information that the treatment will aid in healing and the patient’s condition improves.

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Translate this now to internal controls.

Can an internal control be effective if the company's behaviour is altered in some way by an expectation by the company's employee that the internal control will work.

Take for example using passwords to access your computer network.

Does the password serve the purpose of eliminating the risk of unauthorised entry.

No - a library of hacking case studies is evidence of that.

Does the password serve the purpose of developing an expectation in the user that the system is more secure than would be the case had the password not existed.

Yes.

Is the password therefore a placebo internal control?

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Translate this now into corporate governance.

In 2006, the American Bar Association held a forum on the very topic.

It noted that statistical measures of corporate governance are in vogue in studying how and whether good governance affects a company's performance.

Through the prism of litigation, it asked to what degree does good corporate goverance interact with litigation.

Does good governance promote practices that reduce litigation exposure it asked?

Does good governance itself minimize such exposure?

Or, is good governance merely a placebo?

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Perhaps there is a link therefore between the discipline of behavioural economics and the effective execution of a strong internal control environment.

An interesting presentation was given by Dan Ariely in March 2008.

Dan Ariely is the Alfred P. Sloan Professor of Behavioral Economics at MIT, where he holds a joint appointment between MIT's Media Laboratory and the Sloan School of Management. His work has been featured in The New York Times, the Wall Street Journal, the Washington Post, the Boston Globe, Scientific American, and Science.

In the presentation he discusses the effectiveness of placebos, and outlines how expectations of a given situation will affect our experiences of that situation.