European Journal of Innovation ManagementHow an organization's ethical climate contributes to customer satisfaction and financialperformance : Perceived organizational innovation perspectiveHyoung Koo Moon Byoung Kwon Choi

Article information:To cite this document:Hyoung Koo Moon Byoung Kwon Choi , (2014),"How an organization's ethical climate contributes tocustomer satisfaction and financial performance ", European Journal of Innovation Management, Vol. 17 Iss1 pp. 85 - 106Permanent link to this document:http://dx.doi.org/10.1108/EJIM-03-2013-0020

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Users who downloaded this article also downloaded:Hans Löfsten, (2014),"Product innovation processes and the trade-off between product innovationperformance and business performance", European Journal of Innovation Management, Vol. 17 Iss 1 pp.61-84 http://dx.doi.org/10.1108/EJIM-04-2013-0034Colin C. Williams, Francisco Más Verdú, José A. Belso#Martínez, Byoung Kwon Choi, Hyoung Koo Moon,Wook Ko, (2013),"An organization's ethical climate, innovation, and performance: Effects of support forinnovation and performance evaluation", Management Decision, Vol. 51 Iss 6 pp. 1250-1275Cevahir Uzkurt, Rachna Kumar, Halil Semih Kimzan, Gözde Emino#lu, (2013),"Role of innovationin the relationship between organizational culture and firm performance: A study of the bankingsector in Turkey", European Journal of Innovation Management, Vol. 16 Iss 1 pp. 92-117 http://dx.doi.org/10.1108/14601061311292878

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How an organization’s ethicalclimate contributes to customer

satisfaction and financialperformance

Perceived organizational innovationperspective

Hyoung Koo MoonKorea University, Seoul, Korea, and

Byoung Kwon ChoiSangmyung University, Seoul, Korea

Abstract

Purpose – Researchers in the field of business ethics have posited that an organization’s ethical climatecan benefit for employees as well as organizations. However, most of the prior research has been conductedat the level of the individual, not organization. Thus, the purpose of this paper is to examine how anorganization’s ethical climate has a positive influence on two its performance indicators – customersatisfaction and financial performance – with a perspective of organizational innovation.Design/methodology/approach – The data were collected from 29 subsidiaries of a conglomeratein South Korea. Hypotheses were tested using the partial least squares (PLS).Findings – The result showed that an organization’s ethical climate was positively related tocustomer satisfaction as well as financial performance, and this relationship was mediated byperceived organizational innovation. Additionally, the positive influence of an ethical climateon employees’ perceived organizational innovation was mediated by their organizational commitmentand the climate for innovation.Originality/value – With a focus on innovation, the study explained how an organization’s ethicalclimate influences customer satisfaction and financial performance. Furthermore, as was the case instudies conducted in other developed countries, the results derived from South Korea sampledemonstrated that an ethical climate is critical for organizational performances in developing countries.

Keywords Organizational culture, Organizational innovation

Paper type Research paper

1. IntroductionIt is well recognized that unethical business conduct is detrimental not only toorganizations’ performance but also to their survival (Evans et al., 2012; Ramsey et al.,2007). Researchers have posited that a substantial portion of organizations’ unethicalbehavior is caused by an organization’s ethical climate (Peterson, 2004). Ethical climateis generally defined as the prevailing perceptions of typical organizational practicesand procedures that have ethical content (Martin and Cullen, 2006; Victor and Cullen,1988). In other words, an ethical climate refers to employees’ collective perception ofhow their organizations are ethical, and provides employees with information on whatare ethically right or wrong behaviors within organizations (Barnett and Vaicys, 2000;Martin and Cullen, 2006).

Recently, as the importance of an ethical climate for organizational competivenesshas increased, many prior researchers have tried to examine the antecedents and

The current issue and full text archive of this journal is available atwww.emeraldinsight.com/1460-1060.htm

European Journal of InnovationManagement

Vol. 17 No. 1, 2014pp. 85-106

r Emerald Group Publishing Limited1460-1060

DOI 10.1108/EJIM-03-2013-0020

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consequences of an ethical climate (DeConinck, 2010; Mulki et al., 2006; Schminke et al.,2007; Simha and Cullen, 2012; Weeks et al., 2004). We acknowledge the contributions ofprevious findings; however, there are also some limitations.

First, prior studies have primarily focussed on the consequences of ethical climateat the individual level, such as job satisfaction (Babin et al., 2000; Martin and Cullen,2006; Schwepker, 2001; Simha and Cullen, 2012), ethical decision making (Barnett andVaicys, 2000; Valentine and Barnett, 2007), organizational commitment (Cullen et al.,2003; DeConinck, 2010; Trevino et al., 1998; Tsai and Huang, 2008), and performance(Weeks et al., 2004). Although some studies have examined the relationship between anethical climate and performance at the organizational level (e.g. Choi et al., 2013;Chun et al., 2011), there are limitations in that those studies have used the employees’perceived performance rather than objective financial performances (Verschoor, 1998;Wu, 2002) and/or have focussed on the ethical factors of social performance rather thanan ethical climate (McGuire et al., 1988; Orlitzky et al., 2003; Waddock and Graves,1997). In this regard, it is not clear how an ethical climate is related to objectiveorganizational performances (Choi et al., 2013; Posner and Schmidt, 1987). In addition,while empirical studies have found that an ethical climate is positively related tocustomer satisfaction at the individual level (Jaramillo et al., 2012; Valenzuela et al.,2010; Weeks et al., 2004), there have been few attempts to verify such a relationship atthe organizational level. Hence, it is necessary to investigate whether an organization’sethical climate is positively related to not only financial performance but also customersatisfaction at the organizational level.

In addition, it is apparent that an ethical climate can increase organizationalperformance (Hosmer, 1994; Long and Driscoll, 2008). Due to this assumption of thepositive effect of an ethical climate, while prior studies have focussed on the directrelationship between an ethical climate and organizational performance, an examinationof the mechanisms by which an ethical climate improves performance has beensomewhat neglected. The two recent studies with a focus on organizational innovationillustrate the positive influence of an ethical climate on organizational performance.For instance, Riivari et al. (2012) showed that an ethical culture is positively relatedto organizational strategic and process innovativeness. Choi et al. (2013) have alsoexamined the mediating effect of organizational innovation on the relationship betweenan ethical climate and financial performance. We acknowledge the significance of thesestudies in examining organizational innovation as an internal mechanism to explainthe influence of an ethical climate on organizational performance. However, althoughthese prior studies suggested possible explanatory constructs, such as creative climate(Choi et al., 2013) and rule breaking (Riivari et al., 2012) to explain such relationship, theydid not directly pose or test any hypotheses. Thus, there is still a need for a thoroughexamination of the internal mechanism through which an ethical climate affectsorganizational innovation.

Taken together, this study aims to deepen the understanding of why anorganization’s ethical climate positively influences performances with a perspective oforganizational innovation. Specifically, first, we examine the relationships betweenan ethical climate and objective organizational performance by considering not onlyfinancial performance but also customer satisfaction. Second, by extending previousstudies on the effect of an ethical climate through innovation, this study deeplyinvestigates the internal mediating mechanisms by which an ethical climate leads toorganizational performance through perceived organizational innovation. Specifically,we consider employees’ perceived organizational innovation within the context of the

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relationship between an ethical climate, customer satisfaction, and financial performance.Furthermore, we investigate employees’ organizational commitment and climate forinnovation as mediating variables in the relationship between an ethical climate andperceived organizational innovation.

The hypotheses were empirically tested using data from a conglomerate in SouthKorea. Recently, many South Korean companies have been interested in ethicalmanagement. According to Choi and Nakano (2008), 89 percent of South Koreancompanies have responded that they made a great effort to instill ethical values intotheir organizations, and 47 percent had adopted a code of ethics. Like this, there hasbeen a noticeable increase in South Korean companies committing to business ethics.However, although many South Korean companies are emphasizing ethical business,a substantial number of executives in South Korea seem to question the effectiveness ofethical management for organizational performance. For instance, Lee and Yoshihara(1997) found that over half of the executives of South Korean companies wanted to actethically for their personal values rather than for a business purpose. This means thatmany South Korean executives may not have a strong belief in the benefits of businessethics. Moreover, companies in developing countries such as South Korea may puta priority on short-term economic gains rather than ethical issues. Taken together,the empirical evidences for the benefits of an ethical climate on organizationaleffectiveness will be critical for South Korean companies to internalize the importanceas well as necessity of business ethics.

2. Literature review and hypotheses development2.1 An organization’s ethical climate, customer satisfaction, and financial performanceAn ethical climate is the employees’ shared perception of what ethical behaviors areand how the organization handles ethical issues (Victor and Cullen, 1988). That is,an ethical climate can serve to influence employees’ opinions of what is allowed orprohibited, and to the expected ethical conduct within their organizations (Fein et al.,2013; Valentine and Barnett, 2007). Consistent with previous studies on the relationshipbetween perception of an ethical climate and customer satisfaction at the individual level(e.g. Jaramillo et al., 2012; Valenzuela et al., 2010), it is expected that an organization’sethical climate will have a positive influence on the two types of performances.Three research streams point to these links.

Concerning an ethical climate’s effect on customer satisfaction, the first reason relatesto the corporate image driven by an ethical climate. Given that an organization’s ethicalimage can be positively perceived by customers (Valenzuela et al., 2010), an ethical climateis expected to increase customer satisfaction. Customer satisfaction is generally defined ascustomers’ overall evaluation based on their purchase and consumption experiences withproducts or services (Anderson et al., 2004). One of the critical factors related to customers’satisfaction is their positive perception of ethical image and/or reputation (Valenzuelaet al., 2010). Considering that organizations’ ethics serve as a competitive advantage thatdistinguishes them from competitors, an organization’s ethical business can providea favorable image to customers, and thus encourage consumers to develop positiveattitudes toward the organizations. In this situation, customers are more likely to besatisfied with products and services offered by ethical organizations (Luo andBhattacharya, 2006). Accordingly, an organizations’ ethical image in the market is criticalfor forming customer loyalty and satisfaction (Chiou et al., 2002; Roman and Ruiz, 2005).Accumulated evidences have demonstrated a positive relationship betweenorganizational ethics and customer satisfaction. For instance, Luo and Bhattacharya

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(2006) identified the positive influence of corporate ethics on customer satisfaction.Valenzuela et al. (2010), using a sample from customers of two banks, demonstrated thatcustomer’s perception of the banks’ ethical climate was positively related to customerloyalty. In addition, Roman and Ruiz (2005) found that customers’ perceptionof salespersons’ ethical behavior increased customer satisfaction, trust, and commitmentto those salespersons.

Second, organizations with an ethical climate tend to have appropriate systems thatencourage ethical behavior among employees, thus, can maintain their ethicalreputation. For instance, an organization emphasizing business ethics towardcustomers may take pride in the fact that they conduct business with customers fairlyand ethically. Weeks et al. (2004) argued that an organization emphasizing businessethics would encourage employees to behave toward their customers ethically throughvarious systemic actions such as selecting people with high ethical standards andcustomer orientation, providing training on ethics, aligning ethics with employee’sperformance evaluation, and rewarding ethical behavior.

Third, employees working in ethical organizations are likely to try to build mutuallytrusting relationships with customers and thus project favorable corporate image tocustomers. Customers tend to think that salespeople operate at a lower ethical standardin order to make sales (Ramsey et al., 2007). Indeed, DeConinck (2011) argued thatsalespeople might use unethical tactics with customers to improving theirperformance. In this light, salesperson ethics is important for sustaining mutuallong-term relationships with customers (Evans et al., 2012; Schwepker, 2001).If employees in an ethical organization sell products or services that meet ethicalstandards such as adherence to guidelines on product safety, the customers willperceive the product or services as more reliable (Mulki et al., 2006; Schwepker, 2001),and accordingly customers’ trust in such organizations will increase. Indeed,Valenzuela et al. (2010) argued that customers would be more satisfied withorganizations that employ ethical value and practices, because they tend to think thatsuch organizations produce safe and reliable products or services. In sum, whencustomers perceive that employees work in ethical organizations, they are likely totrust in products or services that employees sell and thus will be more satisfied.

Furthermore, employees working in ethical organizations are likely to try to satisfycustomers. Schwepker and Hartline (2005) argued that a perceived ethical climate servesas a cultural control mechanism that helps employees understand what is ethically goodor bad while treating customers, and thus regulates their behavior according to ethicalcodes of conduct. From this perspective, Schwepker and Hartline (2005) found thatsalespeople who internalized an organization’s code of ethics had a stronger commitmentto service quality, because they thought that conducting sales ethically was desirable notonly for customer satisfaction but also for their own satisfaction. Valentine and Barnett(2007) found that perceived organizational ethics increased employees’ awarenessregarding unethical issues, and helped them to engage in ethical behavior. Taken together,organizations with an ethical climate are expected to achieve higher customer satisfactionthrough not only projecting a positive organizational image to costumers but also throughencouraging employees to make an effort to serve customers effectively:

H1a. An organization’s ethical climate is positively related to customer satisfaction.

On the other hand, when it comes to financial performance, although there are manyinfluencing factors, such as organizational size, industry risk, and human resources

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(Waddock and Graves, 1997), we expect an ethical climate to be a significant predictor.Stakeholder theory provides the theoretical background for the positive relationshipbetween an ethical climate and financial performance. According to stakeholdertheory, stakeholders, such as investors and governments, consider an organization’ssocial responsibility as one of the important determinants affecting their investmentdecisions (Hosmer, 1994; McGuire et al., 1988; Orlitzky et al., 2003). If organizations donot fulfill social responsibilities or do not act in an ethical manner, stakeholders mayimpose financial and/or non-financial sanctions or even terminate their relationshipswith such organizations (Choi et al., 2013). Accordingly, stakeholders’ pressure to fulfillsocial responsibilities and engage in ethical business practices may take a substantialtoll on organizational performance (Luo and Bhattacharya, 2006; Orlitzky et al., 2003).Additionally, stakeholders’ resource allocation decisions are based on an overallevaluation of the organizations’ behavior (Neville et al., 2005; Orlitzky et al., 2003),thus organizations’ ethical behavior can influence the stakeholders’ favorableevaluation of the organizations. In this respect, ethical organizations are expected toderive more support from stakeholders. In summary, organizations with a high ethicalclimate can improve performance while maintaining organizational legitimacy in thesociety by acquiring stakeholder’s support (Hosmer, 1994; Long and Driscoll, 2008).

Indeed, it is well recognized that organizations that stick to ethical standardsor engage in corporate social responsibility achieve higher financial performance(Berrone et al., 2007; McGuire et al., 1988; Neville et al., 2005; Orlitzky et al., 2003;Surroca et al., 2010). Taken together, organizations with an ethical climate will acquiremore resources, such as financial aid, from stakeholders, and thus reflect a higherfinancial performance:

H1b. An organization’s ethical climate is positively related to financial performance.

2.2 The Role of perceived organizational innovationResearchers in the field of organizational innovation consider organizational climate as acritical determinant of innovation (Damanpour, 1991). By regarding ethical climateas a kind of organizational climate, an ethical climate can be a predictor of organizationalinnovation. For this reason, we expect that it is possible to connect an ethical climate andorganizational innovation.

Innovation is defined as “the production of a valuable, useful new product, service idea,or procedure, together in a complex social system” (Woodman et al., 1993, p. 293). Alongwith this objective concept of organizational innovation, researchers also regardemployees’ perceptions of organizational innovation as a predictor of organizationalinnovation (Lin and Liu, 2012; Scott and Bruce, 1994). Perceived organizational innovationrefers to how employees perceive their organization’s willingness to encourage new ideasor creative processes related to the creation of innovative products, process, or technology(Amabile et al., 1996; Uzkurt et al., 2013).

While innovation literature has addressed many organizational factors, such asdistinctive competence (Damanpour, 1991; Hirst et al., 2009), few studies haveexamined an ethical climate as an antecedent of perceived organizational innovation.To fill this research gap, we derive the following hypotheses, from relevant literatures,that an ethical climate can predict employees’ perceived organizational innovation.

First, according to stakeholder theory, organizations that engage in ethical businesspractices are better able to satisfy stakeholders, because ethical business conductdemonstrates that organizations successfully execute their social responsibilities

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( Jones, 1995). Stakeholders’ attention to organizations’ ethical behaviors can forcethem to adopt ethics-related programs such as a code of ethics, training program forethics, and an ethical officer program (Waddock and Graves, 1997). However,establishing and/or implementing these ethics-related programs in responseto stakeholder pressure can come at a substantial organizational cost. As such,organizations that face stakeholders’ ethical restrictions are expected to try to seekout more innovative business practices to resolve those restrictions effectively(Choi et al., 2013).

Second, an ethical climate is associated with pro-social rule-breaking behavior.According to Morrison (2006, p. 6), pro-social rule breaking is defined as employeebehavior that “intentionally violates a formal organizational policy, regulation, orprohibition with the primary intention of promoting the welfare of the organizationor stakeholders.” Examples of pro-social rule breaking include breaking the existingpolicy or traditional rules in order to increase organizational efficiency or to provide bettercustomer service. When employees perceive that their organizations emphasizeethical decision behaviors, they in turn engage in pro-social rule breaking to maintainthe welfare of customers, the community, and organizational members in accordance withethical criteria (Morrison, 2006). In addition, pro-social rule-breaking behavior canpromote organizational innovation by overcoming existing organizational obstaclesrelated to creation of innovative products or services (Brenkert, 2009). Based onstakeholder theory and pro-social rule-breaking behavior, we hypothesize thatorganizations’ ethical climate will force innovative organizational practices andencourage employees’ pro-social rule-breaking behavior, and in turn increaseemployees’ perceived organizational innovation.

On the other hand, employees’ perceived organizational innovation is expectedto mediate the positive influence of an ethical climate on organizational performance.In a related study, Choi et al. (2013) showed that organizational innovation mediated thepositive influence of an organization’s ethical climate on financial performance, suchas sales and revenue growth rates. Altogether, organizations with an ethical climateare expected to demonstrate higher performance through increasing their willingnessand/or desire to innovate:

H2. An ethical climate is positively related to perceived organizational innovation.

H3. Perceived organizational innovation mediates the relationship between anethical climate and two organizational performances (customer satisfaction andfinancial performance).

2.3 The role of employees’ organizational commitmentRecent studies have generally reported that an ethical climate positively influenceemployees’ attitudes toward organizations. Of these attitudes, organizationalcommitment has been thoroughly examined as a consequence of employees’perception of an ethical climate (e.g. Cullen et al., 2003; DeConinck, 2010; Fein et al.,2013; Huhtala et al., 2011; Ruppel and Harrington, 2000; Trevino et al., 1998; Tsai andHuang, 2008). For instance, Martin and Cullen’s (2006) meta-analysis showed thatemployee perception of ethical climate positively affect work outcomes such asorganizational commitment. Although previous studies have examined thisrelationship at the individual level, it is expected that a similar relationship will alsoexist at the organizational level.

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Organizational commitment refers to employees’ psychological acceptance oforganizational values and their willingness to maintain membership within theorganization (Meyer et al., 2002; Mowday et al., 1979). Organizational commitmentincludes three components: affective, normative, and continuance commitment(Meyer et al., 2002). Among these components, we specifically focus on affectivecommitment – the positive affect to the organization – because affective commitmentplays the most important role in employee outcomes, such as job performance andproactive behaviors (Meyer et al., 2002). Employees with affective commitment havea strong psychological attachment to their organizations, and thus behave in a waythat is consistent with the directions or interests of the organization (Simha and Cullen,2012; Weeks et al., 2004).

A social identity theory offers the reasons for the positive association betweenan ethical climate and organizational commitment. According to social identity theory(Ashforth and Mael, 1989), individuals tend to find their self-identity (i.e. who I am) interms of the social relationship with the organization to which they belong (Olkkonenand Lipponen, 2006). That is, individuals’ self-identity is influenced by how they relateto their organization. When seen from this perspective, if employees perceive thattheir organization emphasizes ethical values, adheres to ethical practices, and serves asan ethical role model in society, they will think that their organizations have a goodreputation and high prestige. For this reason, employees are likely to think that theyhave a high-quality relationship with the organization, and will thus emotionallyidentify with organizations that emphasize ethical practices toward customers,the community, and employees (Trevino et al., 1998; Valentine et al., 2006). Throughthis process, employees perceiving an ethical climate can more easily forge a positiveself-identity (Ashforth and Mael, 1989). In addition, organizations striving for ethicalbusiness practices can help employees feel their work is meaningful by conveying itsmoral value, which in turn increase employees’ self-worth ( Jaramillo et al., 2012).In summary, employees in ethical organizations are likely to feel a strong sense ofself-worth about their work, and thus will strongly identify with, and be psychologicallycommitted to, their organizations (Huhtala et al., 2011; Trevino and Brown, 2004).

Indeed, many previous studies offer empirical support for the positive relationshipbetween an ethical climate and organizational commitment. Brammer et al. (2007),drawing on social identity theory, found that employees who perceived that theirorganizations engaged in socially responsible behavior and treated employees with fairprocedures showed higher levels of organizational commitment. With a sample ofmarketing employees, Babin et al. (2000), DeConinck (2010, 2011), and Mulki et al. (2006)found that employees’ perception of an ethical climate was positively related toorganizational commitment, because they were proud to represent an ethical organization:

H4a. An ethical climate is positively related to employees’ organizationalcommitment.

Organizational commitment is also considered as a critical factor in innovation process(Ring and Van De Ven, 1994). When employees had a strong commitment to theirorganization, they would voluntarily demonstrate behavior such as problem solvingand suggesting solutions, which are essential ingredients in innovation (Ruppel andHarrington, 2000). In contrast, consistent with the argument of Ring and Van De Ven(1994), when employees had a low level of commitment, such organizations’ efforts forinnovation would fail. In a related study, Lipponen et al. (2008) found that employees

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highly committed to their organization demonstrated innovative behaviors, such assuggesting new ideas for improving products, processes, and services. Combining theaforementioned relationships among an ethical climate, organizational commitment,and innovation, we hypothesized that organizational commitment mediates therelationship between an ethical climate and organizational innovation:

H4b. Employees’ organizational commitment mediates the relationship between anethical climate and perceived organizational innovation.

2.4 The role of climate for innovationBesides organizational commitment, the present study suggests that an ethical climatecan also facilitate a climate for innovation, which has been well recognized as a significantpredictor of organizational innovation (Amabile et al., 1996). A climate for innovationreflects employees’ aggregated perception of how organizations encourage them to thinkcreatively, freely discuss new ideas, and behave innovatively (Amabile et al., 1996;Scott and Bruce, 1994). The theoretical background for the relationship between an ethicalclimate and a climate for innovation can be described in two respects.

First, an ethical climate can facilitate trusting relationships among employees. In anethical climate, employees are more likely to share openly their valuable ideas andknowledge, as they do not fear that their coworker will steam them. Ellonen et al. (2008)propose that interpersonal trust facilitates knowledge exchange through cultivatingan innovation-friendly atmosphere. Moreover, Tseng and Fan (2011) found that anorganizational ethical climate allowed employees to engage in knowledgemanagement, because their perception of ethical climate reduced the fear of sharingknowledge with others.

Second, besides the interpersonal aspect, an ethical climate is expected to increase thehigh frequency and quality of frank and open communications between leader andemployees. In ethical organizations, so long as employees follow their organization’sethical guidelines, they may feel free to speak what is good or bad (Fein et al., 2013;Parboteeah et al., 2010; Valentine et al., 2006). In other word, while adhering to ethicalnorms in organizations, employees can actively communicate any work or organization-related problems toward managements without fear of incurring negative consequencesfor their opinions (e.g. punishment). Mulki et al. (2006) suggested that when managersand employees share an understanding of the importance and/or necessity of ethics,they communicate well and have a better working relationship. Additionally, an ethicalclimate can contribute to the employee perception that they are supported by theirorganization. For instance, Valentine et al. (2006) showed that employees’ perceptionof organizational ethics leads to high levels of their perceived organizational support.Wang and Hsieh (2012) also found that an ethical climate decreased employees’ silenceby increasing the perception of organizational support. Considering that opencommunication and perceived organizational support are predictors of a climate forinnovation (e.g. Amabile et al., 1996; Wang and Hsieh, 2012), an ethical climate isexpected to be related to a climate for innovation:

H5a. An ethical climate is positively related to a climate for innovation.

Additionally, based on the well-researched previous studies on the positive influenceof a climate for innovation on organizational innovation, we propose the mediatingeffect of a climate of innovation. Previous studies have demonstrated that a climatefor innovation, which encourages employees to take risks and generate, is positively

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related to creative performance (Amabile et al., 1996; Zhou and George, 2001). Insummary, when organizations promote a climate that supports innovation, employeeswill engage in innovational activities, and thus demonstrate innovative performance.Hence, we predict the following hypothesis:

H5b. Climate for innovation mediates the relationship between an ethical climateand perceived organizational innovation.

3. Methods3.1 Sample and data collectionThe data were obtained from a South Korean conglomerate that has approximately40 subsidiaries in diverse industries, such as electronics, chemicals, andtelecommunications. This company was well suited to testing our hypothesesbecause it has emphasized ethical corporate culture since its corporation in the 1940s.One of the conglomerate’s core values was “commitment to ethical business,” whichreflected behaving ethically toward customers and business partners, fulfilling socialresponsibilities, and treating its employees fairly. In this respect, the conglomerate’scommitment to ethical business was comprised of integrity in terms of businessethics (e.g. refusing bribes), fair treatment of internal and external stakeholders(e.g. providing equal opportunities), and maintaining social responsibilities(e.g. compliance with laws and benefiting society). However, because subsidiaries’obedience to ethical business varied widely, the top management team of theconglomerate periodically monitored whether its subsidiaries followed ethical businesspolicies and, when evaluating subsidiaries’ performance, considered the degree towhich they implemented ethical codes of conduct. We thought that the conglomeratewas particularly appropriate to test our hypotheses in light of the variability of ethicalcompliance among its subsidiaries.

In order to monitor and ensure ethical business practices, the conglomeratehas conducted employee annual employee opinion survey to gauge employeeperception of ethical climate and evaluate how well its subsidiaries adhere to theirethical commitments. All subsidiaries have participated in this survey, and mostof each subsidiary’s employees have participated voluntarily. The employeeopinion survey consists of approximately 90 items related to employees’ perceptionsof the degree of a subsidiary’s ethical management as well as various other areassuch as communication, innovation, and confidence in organizational success.Generally, the human resource management team at the conglomerate headquartersdistributes questionnaires to employees in each subsidiary via the intranet, and dataare collected over a three-week period. In this regard, we thought that the conglomeratewas suitable for collecting the data on ethical climate at the organizational level.In summary, the conglomerate was selected for our sample, because we were able totest the relationship between an ethical climate and organizational performance at theorganizational level.

We explained the purpose of this study to a key figure at the conglomerate’s humanresource management team and requested permission to acquire and use their internalsurvey results. Originally, the sample consisted of 32,888 employees from 40subsidiaries in the conglomerate. However, among those subsidiaries, 11 wereexcluded: financial performance information for seven subsidiaries was not availablebecause they were non-public; the other four subsidiaries were excluded because theylacked data on customer satisfaction.

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Ultimately, the final usable sample was 24,591 at the employee level and 29subsidiaries at the organization level (valid response rate¼ 72.5 percent). For eachsubsidiary, the mean of valid response rates was 74.8 percent ranging from 96.0 to51.0 percent. To describe the sample characteristics briefly, for each subsidiary, theaverage number of respondents was 845 ranging from 35 to 5,247. Across subsidiaries,the average age and organizational tenure of respondents were 37.5 years (SD¼ 7.3)and 8.4 years (SD¼ 7.5), respectively. A total of 76.3 percent of the respondents weremale, and 82.8 percent had college education or above. Regarding job title, 94.5 percentwere front-line employees, and 5.5 percent were managers.

3.2 MeasuresAn ethical climate, perceived organizational innovation, organizational commitment,and climate for innovation were self-reported by employees. All items were rated usinga five-point Likert-type scale ranging from strongly disagree (1) to strongly agree(5). Customer satisfaction and financial performance were measured by usingobjective sources.

An organization’s ethical climate. We adopted six items developed by Victor andCullen (1988) to assess an ethical climate. Sample item is “In this organization, it isexpected that I will always do what is right for the stakeholders” (Cronbach’sa¼ 0.874).

Perceived organizational innovation. We measured perceived organizationalinnovation by using three items from the scale of Scott and Bruce (1994). Sampleitem reads “The company searches out new technologies, processes, techniques, and/orideas” (Cronbach’s a¼ 0.744).

Employees’ organizational commitment. Employees’ organizational commitmentwas assessed by two items adopted from frequently used measure (Mowday et al.,1979). Sample item reads “I do not feel emotionally attached to this organization”(Cronbach’s a¼ 0.769).

Climate for innovation. Climate for innovation was assessed by adopting themeasure of Koys and DeCotiis (1991). Sample item is “My leader encourages me to takerisks by trying new things” (Cronbach’s a¼ 0.893).

Customer satisfaction. We obtained the result of the customer satisfaction (CS) indexadministrated by Korea Productivity Center in 2007 with the help of a key person incharge of managing customer satisfaction surveys at the conglomerate’s headquarters.Customer satisfaction index is the score obtained from customers’ evaluations of theirsatisfaction with the products or services. The conglomerate asked Korea ProductivityCenter to conduct annual customer satisfaction surveys for its subsidiaries. KoreaProductivity Center conducted surveys addressing customer satisfaction with productsor services of not only the conglomerate’s subsidiaries but also their competitors.The customer satisfaction scores for the conglomerate’s subsidiaries and theircompetitors range from 0 to 100. We calculated the customer satisfaction score bydividing customer satisfaction score of the subsidiaries by those of their competitors.

Financial performance. A two-year average return on investment (ROI) was used forthe objective measure of financial performance. Sales and revenue data for 2007 and2008 were obtained from the Korea Exchange, which provides financial information forall public companies. We calculated each year’s ROI, divided the revenue by the sales,and averaged the results over two years.

Control variables. Because subsidiaries of the conglomerate are diverse, we includedtypes of industry as a control variable. In addition, organizations with good financial

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performance are able to invest in innovational activities owing to slack resources andmay achieve a subsequent higher financial performance (Surroca et al., 2010).Hence, we controlled sales and revenue as indicators of past performance by using thelogarithm values of sales and revenues for 2006.

3.3 Validity analysesTo confirm the measures’ validity and overall factor structure, we conducted exploratoryand confirmatory factor analyses. First, in the case of explanatory factor analyses, factorloading means the degree to which items are correlated with the focal latent variable theymeasure. In addition, factor loading higher than 0.50 is usually regarded to be highlycorrelated with the latent variable. As shown in Table I, the four factors of an ethicalclimate, perceived organizational innovation, organizational commitment, and climatefor innovation were extracted with an eigenvalue 41, and each item was loaded on itsappropriate factor, with primary loadings exceeding 0.50. Each factor had the explainedvariance of 21.11, 18.90, 17.22, and 9.05 percent, respectively.

Second, regarding the confirmatory factor analyses, we evaluated the goodness of eachmodel whether the values of the comparative fit index (CFI) and the Tucker-Lewis index(TLI) are 40.90, and the value of the root mean-squared error of approximation (RMSEA)is lower than 0.08 (Lance and Vandenberg, 2002). A four-factor model (ethical climate,organizational commitment, climate for innovation, and perceived organizationalinnovation) yielded a good goodness-of-fit index (w2(df)¼ 5,792.2(98), CFI¼ 0.970,TLI¼ 0.959, RMSEA¼ 0.049) and showed a better goodness-of-fit index for thesingle-factor model (w2(df)¼ 28,278.8(104), CFI¼ 0.853, TLI¼ 0.808, RMSEA¼ 0.105),with a significant change of w2 of 335.1 (Ddf¼ 6, po0.001).

3.4 Data aggregationAll items of each variable were aggregated into an organization level, because the unit ofanalysis in this study is the organization ( James et al., 1993; Klein and Kozlowski, 2000).Following the recommendations from James et al. (1993), we checked the appropriatenessof aggregating the responses of each subsidiary’s employees to the organization level byapplying some criteria. First, we calculated within-group agreement statistics (rwg) for allthe variables. The median rwg values of an ethical climate (0.922), climate for innovation(0.893), and perceived organizational innovation (0.807) exceeded 0.70 which is the lowestappropriate value for the aggregation of individual-level measures to an organizationallevel (Klein and Kozlowski, 2000); the only except was organizational commitment (0.543).

Second, to justify further aggregation to the organizational level, we checked the valuesof the intraclass correlation coefficients (e.g. ICC(1) and ICC(2)), which were calculated byone-way ANOVA (Bliese, 2000). The results of the test yielded acceptable values of anethical climate (ICC(1)¼ 0.03, ICC(2)¼ 0.96, F¼ 28.41, po0.001), organizationalcommitment (ICC(1)¼ 0.01, ICC(2)¼ 0.91, F¼ 12.32, po0.001), climate for innovation(ICC(1)¼ 0.02, ICC(2)¼ 0.96, F¼ 26.31, po0.001), and perceived organizationalinnovation (ICC(1)¼ 0.05, ICC(2)¼ 0.98, F¼ 51.55, po0.001), which far exceeded thevalue commonly considered the lowest acceptable (ICC(1)o0.20, ICC(2)40.70) (Klein andKozlowski, 2000). Taken together with values of rwg, ICC(1), and ICC(2), we can justify theaggregation of the response of the individual level to the organizational level.

3.5 Analytical procedureTo test the hypotheses of our study, we conducted partial least squares (PLS) analyseswith Smart PLS 2.0 software, which is a kind of multivariate analysis technique. PLS is

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useful for testing structural models with latent variables, and is especially suitablefor prediction-based studies (Sosik et al., 2009). In addition, PLS is more suitable for theanalysis of small samples and is ideal in the early stages of theory building and testingbecause it does not require normal assumptions about data (Sosik et al., 2009).

Criteria for evaluating a PLS structural model are estimated for path coefficientsand R2 values for dependent variables (Cohen, 1988). The path coefficients in a PLSstructural model are standardized regression coefficients. The significance test of thepath coefficients was conducted using bootstrapping with a recommended subsamplesize of 500. Unlike other structural equation modeling approaches, PLS does notprovide a model fit index. Therefore, R2 values for dependent variables are typicallyused for evaluating the appropriateness of the PLS model fit, and the recommendedcut-off is 10 percent of variance explained in the dependent variables. Moreover, thesignificance of the increase in explained variance with the entering of new variableswas tested by Cohen’s f 2, which is computed by the following formula: (R2

full�R2reduced)/

(1�R2full). Cohen’s f 2 values of 0.02, 0.15, and 0.35 are considered to represent small,

medium, and large effect sizes, respectively (Cohen, 1988).

4. ResultsTable II and III indicates the overall results of our testing hypotheses. First, H1a andH1b predicted that an organization’s ethical climate would be positively relatedto customer satisfaction and financial performance. As seen in Model 2 of Table I,an organization’s ethical climate was positively related to both customer satisfaction(b¼ 0.56, po0.001) and ROI (b¼ 0.55, po0.001). Additionally, the Cohen’s f 2 were 0.44((0.37�0.09)/(1�0.37)) for customer satisfaction and 0.50 ((0.47�0.20)/(1�0.47)) for ROI,which are the large effect sizes of increase in explained variance (DR2) after entering theorganizations’ ethical climate in Model 2. Thus, H1a and H1b were supported.

Second, H2 postulated a positive relationship between an organization’s ethicalclimate and perceived organizational innovation. Model 2 of Table II showed that anorganization’s ethical climate had a positive influence on perceived innovation(b¼ 0.71, po0.001). Thus, H2 was supported.

Customer satisfaction (CS) Financial performance (ROI)Model 1 Model 2 Model 3 Model 1 Model 2 Model 3

Control variablesIndustry –0.10 –0.08 –0.20*** 0.10 0.12 0.02

(1.13) (1.26) (3.79) (1.32) (1.82) (0.40)Past revenue 0.36* 0.07 0.26* 0.68*** 0.40** 0.54***

(2.43) (0.58) (2.27) (4.70) (3.00) (5.08)Past sales –0.14 0.04 –0.42*** –0.04** –0.21 –0.58***

(0.90) (0.33) (3.46) (2.56) (1.49) (5.92)PredictorsAn organization’s ethical climate 0.56*** –0.04 0.55*** 0.08

(8.00) (0.51) (10.63) (0.93)Perceived organizational innovation 0.85*** 0.65***

(10.13) (5.93)R2 0.09 0.37 0.62 0.20 0.47 0.62f 2 0.44 0.65 – 0.50 0.39

Notes: Bootstrap n¼ 500. All values are standardized path coefficients and values in parenthesis aret-values. *po0.05; **po0.01; ***po0.001

Table II.Results of testing

relationships among anorganization’s ethical

climate, perceivedorganizational innovation,customer satisfaction, and

financial performance

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Third, Model 3 of Table II supported H3 regarding the mediating effects ofperceived organizational innovation. When perceived organizational innovationwas entered in Model 3, the significant influence of an organization’s ethical climatefound in Model 2 was not significant in Model 3 for customer satisfaction(b¼ –0.04, ns) and for ROI (b¼ 0.08, ns). Instead, perceived organizational innovationwas significant for customer satisfaction (b¼ 0.85, po0.001) and ROI (b¼ 0.65,po0.001) and had the large effect sizes (Cohen’s f 2¼ 0.65 ((0.62�0.37)/(1�0.62)) forcustomer satisfaction and Cohen’s f 2¼ 0.39 ((0.62�0.47)/(1�0.62))) for ROI. Thus,H3 was supported.

Fourth, Table III showed that an organization’s ethical climate has positivezeffects on employee’s organizational commitment (b¼ 0.51, po 0.001) and climate forinnovation (b¼ 0.83, po0.001), and thus H4a and H5a were supported. Furthermore,as seen in Model 3 of Table III, an employee’s organizational commitment (b¼ 0.23,po0.01) and climate for innovation (b¼ 0.64, po0.001) also were positively associatedwith perceived organizational innovation. However, when organizational commitmentand a climate for innovation were included as mediator in Model 3, the significantinfluence of an organization’s ethical climate on its innovation found in Model 2 was nomore significant (b¼ 0.05, ns), and these two variables had a large effect size withCohen’s f 2¼ 0.56 (0.77�0.64)/(1�0.77). This result indicated that an organization’sethical climate positively influenced its innovation through increasing employee’sorganizational commitment and climate for innovation. Thus, H4b and H5b weresupported. Figure 1 summarized the overall results of testing hypotheses.

5. DiscussionDrawing on stakeholder theory, organizational innovation, and organizational behavior-related theory, the present study aimed to theoretically explain and empirically test whyan ethical climate increases organizational performance. We found that employees’perceived innovation mediated the positive influence of an organization’s ethical climate

Perceived organizational innovationModel 1 Model 2 Model 3

Organizationalcommitment

Climate forinnovation

Control variablesIndustry 0.11 0.14** 0.41***

(1.51) (2.90) (5.40)Past revenue 0.13 –0.22* –0.07

(1.20) (2.16) (0.07)Past sales 0.31** 0.55*** 0.28**

(2.81) (5.96) (3.18)PredictorsAn organization’s ethical climate 0.71*** 0.05 0.51*** 0.83***

(13.60) (0.30) (8.82) (44.93)Organizational commitment 0.23**

(3.05)Climate for innovation 0.64***

(4.84)R2 0.19 0.64 0.77 0.26 0.70f 2 1.25 0.56

Notes: *po0.05; **po0.01; ***po0.001

Table III.Results of testingrelationships among anorganization’s ethicalclimate, organizationalcommitment, climate forinnovation, and perceivedorganizational innovation

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on customer satisfaction and financial performance. In addition, employees’ organizationalcommitment and climate for innovation played linking roles in the relationship betweenan ethical climate and perceived organizational innovation. In summary, our studyhas contributed to the ethical climate literature by examining how an ethical climate leadsto higher customer satisfaction and financial performance through identifying themediating mechanism of perceived organizational innovation, and conducting empiricaltests at the organizational level by utilizing the aggregated perception of an ethical climateas well as objective performance data. In this section, we further specifically highlightthe theoretical and practical implications of the current study along with directions forfuture research.

This study provides two theoretical contributions to the ethical climate literature.First, we have opened the black box on the relationship between an ethical climate andorganizational performance. As our findings show, an organization’s ethical climatepositively influenced customer satisfaction and financial performance through perceivedinnovation. Additionally, we enhance our understanding of how an ethical climateinfluences employees’ perceived innovation by verifying organizational commitment anda climate for innovation at the organizational level.

Moreover, given the lack of research on an ethical climate in developing countries,the present study, with a sample of South Korean, on the effect of an organization’sethical climate on its customer satisfaction as well as financial performance throughthe lens of innovation constitutes a meaningful contribution to the business ethicsliterature. Previous studies using samples from developed countries, such as the USA,have found that organizational ethics and/or corporate social responsibility waspositively related to financial performance (e.g. Berrone et al., 2007; Surroca et al., 2010;Waddock and Graves, 1997); however, with few exception (e.g. Choi et al., 2013; Chunet al., 2011), there has been a lack of empirical verification of these hypotheses in the

Notes: CS, customer satisfaction, ROI, two-year averaged ROI. * p<0.05; **p<0.01;*** p<0.001, two-tailed test

AnOrganization’sEthical Climate

OrganizationalCommitment

Climate forInnovation

PerceivedOrganizational

Innovation

OrganizationalPerformance

Industry PastRevenue

0.51***

0.83***

0.23**

0.64***

0.05

0.85*** (CS)0.65*** (ROI)

0.41*** 0.28***

R 2= 0.26

R 2= 0.70

R 2= 0.77 R 2=0.62 (CS)R 2=0.62 (ROI)

PastSales

–0.04 (CS)0.08 (ROI)

–0.07

0.26* (CS)0.54*** (ROI)

–0.20*** (CS)0.02 (ROI)

–0.42*** (CS)–0.58*** (ROI)

Figure 1.Results of testing overall

research model

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context of developing countries. As was the case in other studies that focussed ondeveloped countries, our study using a South Korea sample also demonstrates that anorganization’s ethical climate increase customer satisfaction and financialperformance. In this respect, our study offers evidence for the importance of anethical climate in both developed and developing countries. In sum, the current studyfills the research gap in an ethical climate through examination of under-examinedsamples, such as organizations in developing countries.

The second contribution relates to extension of the ethical climate literature throughintegrating organizational innovation perspectives. Indeed, there has been a lack ofresearch on ethics in innovation literature. Although some prior studies (e.g. Choi et al.,2013; Riivari et al., 2012) found a positive association between an ethical climate andorganizational innovation, the theoretical explanations seemed weak. This study tried tofill this gap by attempting to derive theoretical reasons why an ethical climate facilitatesorganizational innovation and why organizational innovation plays a mediating rolethrough reviewing the relevant literature. In this respect, in line with the work of Choiet al. (2013), this study seeks to extend the role of organizational innovation in ethicalclimate literature through investigating the internal mechanisms of the relationshipbetween an ethical climate and perceived organization.

From the practical viewpoint, a couple of implications for organizations can bedrawn from this study. The first implication is that employees’ aggregated perceptionsof their organization’s ethical climate may be more important than the mere existenceof ethics-related formal systems (Riivari et al., 2012). Formal systems, such as codes ofethics, might help to create an ethical climate. However, if employees do not perceivetheir organization’s climate as ethical, organizational innovation, customer satisfaction,and financial performance are less likely to be improved. In this respect, organizationsshould pay close attention to cultivating an organization’s ethical climate as well asestablishing formal ethical systems (Schminke et al., 2007; Schwepker and Hartline,2005; Valentine and Barnett, 2007; Weeks et al., 2004). In order to accomplish this,top management must continuously emphasizes ethics to employees, and mustdemonstrate the organization’s willingness to engage in ethical business by monitoringunethical conducts and/or rewarding ethical behaviors.

Second, given the finding that the positive influence of an ethical climate onperceived organizational innovation was mediated by employees’ organizationalcommitment and a climate for innovation, organizations should take appropriateactions to enhance employees’ psychological attachment to the organization and toencourage an innovative atmosphere (Babin et al., 2000; Parboteeah et al., 2010). It maybe recommendable to survey periodically the degree to which managers try to fosterinnovative atmospheres, or to which employees suggest innovative ideas and sharethem with coworkers.

Finally, our study indicates that organizations in developing countries must commit toforming an ethical climate. Organizations in developing countries tend to focus oneconomic returns, because speedy growth is preferable to ethical conduct (Smeltzer andJennings, 1998). However, striving for mere economic gain may result in unethicalbusiness conduct. As our findings indicate, an ethical climate can be a factor in satisfyingcustomers and increasing financial performance through promoting employees’innovative behaviors (Trevino et al., 1998). Hence, top management in developingcountries should understand the importance of an ethical climate and make efforts to it.

Despite these contributions, the current study has some limitations. The first limitationis the causal relationships among ethical climate, perceived organizational innovation,

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and performance. Although we tested our hypotheses with time lags and included pastperformance as control variables, the time interval might be too short to verify truecausality. In addition, organizations with higher financial performance may be innovativeor have an ethical climate because such organizations may have enough slack resourcesto implement innovative activities or adopt ethics-related systems (Luo and Bhattacharya,2006). In this respect, a longitudinal research design is needed to examine the causalrelationship among an ethical climate, organizational innovation, and its performance.

Second, there is a generalizability issue. Considering that we collected data froma conglomerate in South Korea, we cannot guarantee that the current findings willapply to other types of organizations or different nations. Hence, future research withdata from diverse forms of organization as well as from various countries isrecommended to verify whether our results are applicable to other contexts.

Third, consistent with prior studies (e.g. Martin and Cullen, 2006; Trevino andBrown, 2004), we considered employees organizational commitments as a mediatingvariable in the relationship between ethical climate and organizational innovation.However, organizational commitment might be a moderating variable. For instance,although employees perceive an organization to be ethical, if they are not committed totheir organization, it is unlikely that they will be highly motivated to innovate. In thisregard, we suggest that future studies are necessary to examine the possibility ofmoderating effect of organizational commitment.

Fourth, in terms of measurement, our study has a limitation in that we measured theemployees’ perceptions of organization innovation rather objective innovation.Additionally, although we used some intermediating variables (i.e. rule-breakingbehavior and feeling of pride) to theoretically explain the relationships in our researchmodel; unfortunately we did not measure them. Accordingly, we cannot be sure thatour hypothesized relationships worked as expected. In the future, researchers shouldverify that the relationships in our study operate in accordance with our theoreticalreasoning by measuring organizational innovation in objective terms as well asdirectly measuring the intermediating variables.

Fifth, although we controlled for industry type and past financial performance, theremight be other possible factors influencing customer satisfaction or financialperformance, such as organizational size, industry risks, and human resourcescharacteristics. Future research needs to control rigorously possible predictors toinvestigate accurately the effect of an ethical climate.

In conclusion, despite the importance of an organization’s ethical climate to improvecustomer satisfaction and financial performance, little attention has been paid to theinternal mechanisms through which an ethical climate affects customer satisfaction andfinancial performance. Through the perspective of innovation, this study contributes toethics literature by investigating mediating effects of employees’ perceivedorganizational innovation, organizational commitment, and climate for innovation.

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Further reading

Weaver, G.R., Trevino, L.K. and Cochran, P.L. (1999), “Integrated and decoupled corporate socialperformance: management commitments, external pressures, and corporate ethicspractices”, Academy of Management Review, Vol. 42 No. 5, pp. 539-552.

About the authors

Professor Hyoung Koo Moon received a PhD in Organizational Behavior at the University ofMinnesota. He is a Professor in the Department of Business Administration at the KoreaUniversity. His research interests include business ethics, organizational citizenship behavior,organizational justice, and trust.

Byoung Kwon Choi received a PhD in Organizational Behavior at the Korea University. He isan Assistant Professor in the College of Business, Division of Business Administration at theSangmyung University. His research interests include organizational climate, organizationalinnovation, organizational justice, and feedback-seeking behavior. Byoung Kwon Choi is thecorresponding author and can be contacted at: jrpfeffer@smu.ac.kr

To purchase reprints of this article please e-mail: reprints@emeraldinsight.comOr visit our web site for further details: www.emeraldinsight.com/reprints

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