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The causes and consequences of accounting fraud

Author

Listed:
  • Mason Gerety

    (Department of Finance, Northern Arizona University, Flagstaff, AZ USA)

  • Kenneth Lehn

    (Katz School of Business, University of Pittsburgh, Pittsburgh, PA USA)

Abstract

One of the fundamental purposes of corporate accounting is to facilitate the monitoring of managers. Since managers are instrumental in the production of accounting numbers, and since it is costly to monitor their behavior in this regard, firms sometimes report fraudulent accounting numbers. This paper tests several hypotheses concerning why some firms, and not others, commit accounting fraud. This is accomplished through examination of a sample of 62 firms charged with disclosure violations by the Securities and Exchange Commission (SEC) during the period 1981-1987. We also examine whether directors of companies that commit accounting fraud are disciplined in the managerial labor market. We adopt the perspective that the decision to commit fraud is governed by the expected costs and benefits of this behavior (This approach to the study of fraud has been used elsewhere, e.g. Darby and Karni (1973); Michael R. Darby and Edi Karni, “Free Competition and the Optimal Amount of Fraud”, Journal of Law and Economics 16 (April 1973), 68-88. For a brief discussion of the economics of fraud, see Edi Karni (1989) “Fraud” in The New Palgrave: Allocation, Information, and Markets, edited by John Earwell, Murray Milgate, and Peter Newman, New York: W.W. Norton, 117-119). Accordingly, a theory of accounting fraud requires an understanding of how these costs and benefits vary across firms. Those costs and benefits can be varied by external forces, through institutions such as equity markets and independent auditors, or internally through the design of monitoring and reward systems. We will divide our attention between the external and internal forces that change the costs and benefits of accounting fraud. © 1997 John Wiley & Sons, Ltd.

Suggested Citation

  • Mason Gerety & Kenneth Lehn, 1997. "The causes and consequences of accounting fraud," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 18(7-8), pages 587-599.
    • Handle: RePEc:wly:mgtdec:v:18:y:1997:i:7-8:p:587-599
    DOI: 10.1002/(SICI)1099-1468(199711/12)18:7/8<587::AID-MDE855>3.0.CO;2-R
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    Citations

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    Cited by:

    1. Peter-Jan Engelen, 2011. "Legal versus Reputational Penalties in Deterring Corporate Misconduct," Chapters, in: Mehmet Ugur & David Sunderland (ed.), Does Economic Governance Matter?, chapter 4, Edward Elgar Publishing.
    2. Yanmin Gao & Jeong-Bon Kim & Desmond Tsang & Haibin Wu, 2017. "Go before the whistle blows: an empirical analysis of director turnover and financial fraud," Review of Accounting Studies, Springer, vol. 22(1), pages 320-360, March.
    3. J. Mulherin, 2005. "Corporations, collective action and corporate governance: One size does not fit all," Public Choice, Springer, vol. 124(1), pages 179-204, July.
    4. Dan Amiram & Zahn Bozanic & James D. Cox & Quentin Dupont & Jonathan M. Karpoff & Richard Sloan, 2018. "Financial reporting fraud and other forms of misconduct: a multidisciplinary review of the literature," Review of Accounting Studies, Springer, vol. 23(2), pages 732-783, June.
    5. Pulina, Manuela & Paba, Antonello, 2010. "A discrete choice approach to model credit card fraud," MPRA Paper 20019, University Library of Munich, Germany.
    6. Yin Liu & Huiqi Gan & Khondkar Karim, 2020. "Corporate risk-taking after adoption of compensation clawback provisions," Review of Quantitative Finance and Accounting, Springer, vol. 54(2), pages 617-649, February.
    7. Ferris, Stephen P. & Yan, Xuemin (Sterling), 2007. "Do independent directors and chairmen matter? The role of boards of directors in mutual fund governance," Journal of Corporate Finance, Elsevier, vol. 13(2-3), pages 392-420, June.
    8. Street, Daniel A. & Hermanson, Dana R., 2019. "How do restatements affect outside directors and boards? A review of the literature," Journal of Accounting Literature, Elsevier, vol. 43(C), pages 19-46.
    9. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.
    10. Spronk, Jaap & van der Wijst, Nico, 2005. "Financial modelling and the quality of corporate reports," European Journal of Operational Research, Elsevier, vol. 161(2), pages 295-297, March.
    11. Bargeron, Leonce L. & Lehn, Kenneth M. & Zutter, Chad J., 2010. "Sarbanes-Oxley and corporate risk-taking," Journal of Accounting and Economics, Elsevier, vol. 49(1-2), pages 34-52, February.
    12. Reurink, Arjan, 2016. "Financial fraud: A literature review," MPIfG Discussion Paper 16/5, Max Planck Institute for the Study of Societies.
    13. Alexander, Cindy R. & Cohen, Mark A., 1999. "Why do corporations become criminals? Ownership, hidden actions, and crime as an agency cost," Journal of Corporate Finance, Elsevier, vol. 5(1), pages 1-34, March.
    14. Frederick L. Bereskin & Clifford W. Smith Jr., 2014. "Mechanisms of Board Turnover: Evidence From Backdating," Journal of Applied Corporate Finance, Morgan Stanley, vol. 26(2), pages 65-78, June.
    15. So-Jin Yu & Jin-Sung Rha, 2021. "Research Trends in Accounting Fraud Using Network Analysis," Sustainability, MDPI, vol. 13(10), pages 1-26, May.
    16. Liz Washington Arnold & Peter Harris, 2012. "An Empirical Analysis Of Market Reaction To Corporate Accounting Malfeasance," Accounting & Taxation, The Institute for Business and Finance Research, vol. 4(1), pages 25-42.
    17. Laure de Batz & Evžen Kočenda, 2024. "Financial crime and punishment: A meta‐analysis," Journal of Economic Surveys, Wiley Blackwell, vol. 38(4), pages 1338-1398, September.
    18. Chao Fu & Xiuyuan Deng & Hongfei Tang, 2023. "Who cares about corporate fraud? Evidence from cross-border mergers and acquisitions of Chinese companies," Review of Quantitative Finance and Accounting, Springer, vol. 60(2), pages 747-789, February.
    19. Armstrong, Christopher S. & Core, John E. & Guay, Wayne R., 2014. "Do independent directors cause improvements in firm transparency?," Journal of Financial Economics, Elsevier, vol. 113(3), pages 383-403.
    20. narjess BOUABDALLAH & jamel Eddine HENCHIRI, 2020. "L' impact des mécanismes de gouvernance interne sur le risque opérationnel bancaire," Journal of Academic Finance, RED research unit, university of Gabes, Tunisia, vol. 11(1), pages 151-189, June.

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