The role of managers’ attitudes in corporate fraud: Extending auditing standards
Jeffrey Cohen, Yuan Ding, Cédric Lesage and Hervé Stolowy
This draft – March 11, 2008 – Please do not cite or circulate without permission – Comments welcome Jeffrey R. Cohen, PhD is an Associate Professor at the Carroll School of Management at Boston College. His research focuses primarily on behavioral ethics issues as well as investigating governance from a behavioral perspective. Yuan Ding, PhD is a Professor at the China-Europe International Business School (CEIBS), Shanghai, China. His research focuses primarily on international accounting as well as studying accounting and corporate scandals. Cédric Lesage, PhD is a Senior Associate Professor at the HEC School of Management, Paris, France. His research focuses primarily on auditing and financial reporting. Hervé Stolowy, PhD is a Professor at the HEC School of Management, Paris, France. His research focuses primarily on international accounting and accounts manipulation. Cédric Lesage and Hervé Stolowy acknowledge the financial support of the HEC Foundation (Project F). They are members of the GREGHEC, CNRS Unit, UMR 2959. The authors thank José Allouche, Eve Chiapello, Huong Higgins, Michel Lebas and workshop participants at the University of Paris I Pantheon Sorbonne (February 2008) for helpful comments and acknowledge Claire O’Hana for her able research assistance.
The role of managers’ attitudes in corporate fraud: Extending auditing standards
ABSTRACT. During the wave of corporate frauds involving companies such as Enron, WorldCom, and Parmalat, auditors were under heavy criticism for failing to detect the frauds from the financial press as well as from regulatory bodies such as the Securities and Exchange Commission (SEC). Many argue (e.g., Benston and Hartgraves 2002) that these alleged audit failures are linked to the perceived lack of independence of auditors as a result of their offering both auditing and consulting services to their clients. However, a close analysis of professional auditing standards reveals that morals and ethics are perhaps not sufficiently emphasized as fraud risk factors. Based on anecdotal evidence from press articles related to 39 high profile alleged or acknowledged corporate frauds, this study uses the case analysis approach to apply the theory of planned behavior to document fraud cases. The results of the analysis suggest that morals, proxied by the concept of “attitudes”, are a major fraud risk factor. Therefore, it is potentially important to strengthen the emphasis on morals and ethics in the auditing standards that are related to fraud detection.
KEY WORDS: Attitudes, fraud auditing standards, fraud triangle, corporate fraud, theory of planned behavior
The role of managers’ attitudes in corporate fraud: Extending auditing standards
Starting in the late 1990s, a wave of corporate frauds involving many big names spread with Enron’s failure perhaps being the emblematic example. Public opinions and the media often accused auditors for not acting diligently to detect these frauds on time (e.g., Byron 2002; PR Newswire 2002). The press also pointed out that auditors lacked independence because of the potential conflict of interests with their clients that resulted from the auditing firms offering both significant consulting and auditing services (Schneider et al. 2006). The adverse publicity surrounding auditor client relationships that was personified by Arthur Andersen’s cozy relationship with Enron, contributed to the demise of Arthur Andersen, one of the then Big Five firms in auditing. If independence issues have been widely documented by research and regulatory bodies (e.g., Lu 2006; Schneider et al. 2006), we would like to examine an additional dimension of the auditor’s behavior: is there any room for improvements in existing auditing standards that would result in auditors potentially being more effective in deterring and detecting corporate frauds in the future? Are existing auditing standards useful guidance for auditors in their ability to detect fraud? The objective of this paper is to examine documented corporate fraud cases to evaluate if auditing standards may be enhanced to perhaps improve the ability of auditors to detect fraud. An examination of prior literature reveals that the likelihood of committing fraud has been investigated in a number of different ways, using essentially financial variables (e.g., growth, leverage) and/or governance variables (e.g., board size and composition, audit committee, auditor type). A first category of articles has studied the accounting restatements (e.g., Abbott et al. 2004; Kinney Jr. et al. 2004; Agrawal and Chadha 2005; Srinivasan 2005) while a second one has explored fraud cases, as identified by the SEC in its Accounting and Auditing Enforcement Releases (e.g., Beasley 1996; Dechow et al. 1996; Farber 2005; Erickson et al. 2006). The findings of Uzun et al. (2004), using cases as identified in the financial press, suggest that board composition and the structure of a board’s oversight committees are significantly correlated with the incidence of corporate fraud (see also Sharma 2004). Sen (2007) shows in an analytical setting that increased ownership may not necessarily reduce the propensity to commit fraud.
A few reviews have been published on fraud cases. Eilifsen and Messier (2000) study the role of auditors in errors’ (whether intentional or not) detection while Nieschwietz, Schultz and Zimbelman (2000) concentrate on the auditor’s role in terms of fraud detection. Caster, Massey and Wright (2000; discussed by Kinney 2000) model the error generation and detection and Rezaee (2005) studies several fraud cases and proposes strategies for fraud prevention and detection. Loebbecke et al. (1989) use an audit planning model for assessing the likelihood of material management fraud. They find that the auditor should make separate assessments of material errors, material defalcations, and material management fraud during audit planning, and that this model for assessing material management fraud holds promise as an engagement tool. In addition to this finance, governance and audit planning literature, the moral, ethical, psychological and sociological aspects of fraud have also been covered by the literature. Albrecht et al. (1982, p. 31-37) suggest that there are three explanations of crime: psychological, sociological and moral development. The ethical component of several corporate scandals has been documented. For example, Zandstra (2002, p. 16) posits that the central reason for Enron’s demise was a failure of the board of directors to function in a morally and ethically responsible manner. Shafer (2002) examines fraudulent financial reporting within the context of Jones’ (1991) ethical decision making model. He finds that quantitative materiality did not influence ethical judgments. Thorne et al. (2003) study the auditor’s moral reasoning, applying the cognitive developmental theory of Kohlberg (1958, 1979) and the measurement tools proposed by Rest (1979). They find that national institutional context is associated with differences in auditors’ moral reasoning. Elias (2002) examines the ethics of the earnings management practice. His results indicate a positive relationship between social responsibility, focus on long-term gains, idealism and the ethical perception of earnings management and a negative relationship between focus on short-term gains relativism and the ethical perception of this practice. Rezaee (2002, 2005) finds five interactive factors which explain several high-profile financial statements frauds. These factors are: cooks, recipes, incentives, monitoring and end results, with the abbreviation of CRIME. Choo and Tan (2007) also explain corporate fraud by relating the fraud triangle to the “broken trust theory” introduced by Albrecht et al. (2004) and to an “American Dream” theory 1 which originates from sociological literature. Schrand and Zechman (2007) relate executive overconfidence and the commitment of fraud. Not referring
specifically to fraud but to questionable payments issue, Rosenberg (1987) examines the effect of managers’ value systems and personality traits on ethical decision behavior. This paper relates to the “moral development” stream mentioned by Albrecht et al. (1982). It evaluates corporate fraud within the context of the “fraud triangle”. The fraud triangle states that corporate fraud is a function of incentives, opportunities and attitudes. In order to focus on the “attitudes” concept, we relate the concept of the fraud triangle to the theory of planned behavior (Ajzen 1991) (hereafter TPB) and show the relationship which exists between the fraud triangle and the TPB. We then apply the fraud triangle matched with the TPB to a large number of high profile corporate frauds based on anecdotal evidence from press articles. The results of our analysis confirm that attitudes are a key risk factor of corporate frauds and that the fraud triangle, matched with the theory of planned behavior, is a useful framework in which to analyze corporate fraud. A close analysis of existing auditing standards reveals that morals and ethics are not perhaps sufficiently emphasized to the extent that they potentially could be. In the relevant fraud detection standards in the US and internationally (SAS 99 (AICPA 2002) and ISA 240 (IFAC (International Federation of Accountants) 2005), morals and ethics are mostly covered under the rubric of “attitude”. In the SAS 99, for example, this concept is not defined as such. The standard only refers to “some individuals [which] possess an attitude, character, or set of ethical values” (§ 7). Therefore, our paper suggests that auditors should place greater consideration of the moral factor in order to be more effective in detecting corporate frauds. More broadly, by identifying the key drivers of corporate frauds, we help all sorts of constituents (investors, creditors, auditors, market intermediaries and regulators) better understand, assess, and respond to possible frauds in the corporate world. We contribute several new features to the existing literature on corporate fraud: (1) from a theoretical perspective, we show the close relationship between the fraud triangle and the theory of planned behavior applied to fraud; (2) from an experimental perspective, we work on real behaviors of corporate fraud cases, as identified by the press, and not on predicted behaviors and (3), from a regulatory perspective, we highlight the incompleteness of recent auditing standards. The remainder of this paper is organized as follows. The next section presents our analytical framework, which is based on the fraud triangle and the theory of planned behavior. The
following section discusses our sample, research design and results. The last two sections present a discussion and some directions for future research. Corporate fraud: the analytical framework Several conceptual frameworks have been put forward to investigate why managers engage in corporate fraud. In this section, we define the concept of fraud and the “fraud triangle” theory or model 2 that leads to the auditing standards regulation. We will then detail the evolution of auditing and highlight two complementary theories: the “fraud triangle” and the “theory of planned behavior”. Fraud, morals and ethics in auditing regulation We are interested in accounting or corporate “fraud”, as defined in SAS No. 99 (AICPA 2002, § 5): “fraud is an intentional act that results in a material misstatement in financial statements that are the subject of an audit”. In the previous literature, decomposing overall fraud-risk assessments into separate assessments for management’s (1) incentives/pressures, (2) opportunities and (3) rationalizations/attitudes is often referred to as the fraud-triangle decomposition (Wilks and Zimbelman 2004) or, in short, the fraud triangle. These elements were first identified by Sutherland (1949), and developed by Cressey (1953, p. 30).3 Albrecht et al. (1982, p. 37) adapted the concept from criminology to accounting and reinforced the decomposition with a review of over 1,500 references on fraud. They identify 82 fraud-related variables which they combine into three forces; situational pressures, opportunities to commit fraud and personal integrity (character). Auditing regulation (AICPA 1988, 1997, 2002) has outlined numerous fraud-risk factors. These indicators are also called “red flags” and represent “potential symptoms existing within the company’s business environment that would indicate a higher risk of an intentional misstatement of the financial statements” (Price Waterhouse 1985, p. 31; Pincus 1989, p. 154). For example, SAS No. 82 (AICPA 1997) identified three categories of risk factors: (1) Management’s characteristic and influence over the control environment, (2) industry conditions and (3) operating characteristics and financial stability. The same standard highlights two factors: (1) susceptibility of assets to misappropriation and (2) control, when it takes into account the risk factors relating to the second category of misstatements, those arising from misappropriation of assets.
Compared to its predecessors, the most recent standard, SAS No. 99 (AICPA 2002, § 7) has structured the risk factors around three conditions which generally are present when fraud occurs. “First, management or other employees have an incentive or are under pressure, which provides a reason to commit fraud. Second, circumstances exist—for example, the absence of controls, ineffective controls, or the ability of management to override controls—that provide an opportunity for a fraud to be perpetrated. Third, those involved are able to rationalize committing a fraudulent act. Some individuals possess an attitude, character, or set of ethical values that allow them to knowingly and intentionally commit a dishonest act” (italics in the original text). These definitions are directly linked to the fraud triangle. Empirical research has already been carried out to demonstrate the importance of the “incentives” factor in the commitment of the fraud, namely because of aggressive earnings target (Albrecht and Romney 1986; Loebbecke et al. 1989; Bell and Carcello 2000). But when we look closer at the evolution of the regulation, we observe that there is an increasing concern for fraud in auditing regulation and an increasing integration of the attitudes/rationalizations factor. The concept of “attitude” (or “attitudes”, the plural form being also used in the different texts) is now part of one of the three components of the fraud triangle; the “attitudes/rationalizations”. This individualization of the concept constitutes an improvement in the evolution of the auditing standards (from SAS 53 to SAS 994). However, if we pay more attention to the relevant section of SAS 99 quoted above, “attitude”, although highlighted with the italicized characters, is one of the individual’s characteristics: as mentioned earlier, the text also mentions the “character and set of ethical values” of the individual. Further, in the “examples of fraud risk factors” (AICPA 2002, Appendix, p. 44), section “Attitudes/Rationalizations”, paragraph 1 concerns the “Ineffective communication, implementation, support, or enforcement of the entity’s values or ethical standards by management or the communication of inappropriate values or ethical standards”. This item is mostly related to the firm’s ethics. No other item focuses directly on individual ethics or morals. 5 This discussion leads us to a preliminary conclusion: the question of the comprehensiveness of auditing guidelines in relation to this factor remains open. Theory of planned behavior One origin of this paper is the will of the authors to understand why prominent managers of high profile companies decided to engage in fraudulent behaviors, in spite of an already large success, at a personal or a firm’s level. We want then to focus our analysis on the concept of “attitudes”, 7
which is not clearly defined in auditing standards, as mentioned above. However, this concept of “attitude” has been documented in social psychology, more specifically in the theory of planned behavior, which includes the “attitude” as an explanatory element to predict behavior. Ajzen (1991, p. 179; 2001) emphasizes the role of intentions in explaining behaviors and posits that intentions to perform behaviors of different kinds can be predicted with high accuracy from (1) attitudes toward the behavior, (2) subjective norms and (3) perceived behavioral control. According to Ajzen (1991, p. 188), the “attitude toward the behavior … refers to the degree to which a person has a favorable or unfavorable evaluation or appraisal of the behavior in question”. Bailey (2006, p. 804-805) add that the “attitude” toward the behavior is determined by a person’s beliefs that the behavior leads to certain outcomes and the person’s evaluation of those outcomes, favorable or unfavorable. A “subjective norm” refers to the social pressure a person feels from important others to perform or refrain from performing the behavior and to the person’ motivation to comply with those pressures (Hess 2007, p. 1785). “Perceived behavioral control” is the person’s perception of how easy or difficult it is to engage in the particular behavior. (Bailey 2006, p. 804-805). In other words, it represents the person’s ability to perform the behavior, based on their past experience, competence and any expected obstacles they may face (Hess 2007, p. 1785). The relationship between these three predictors of intention is called the “theory of planned behavior”. It is an extension of the “theory of reasoned action” (TRA hereafter) (Fishbein and Ajzen 1975; Ajzen and Fishbein 1980) which only included the first two components of the model (attitude and social norms). As noted by Hess (2007, p. 1784), the TPB is a “parsimonious model but has significant power in explaining variations in intentions. The simplicity of the model also makes it useful for understanding and explaining the various studies that have been conducted on ethical behavior in organizations”. TPB and TRA have already been used to explain the intentions of fraudulent financial reporting. Gillett and Uddin (2005) test a structural model based on reasoned action theory, including attitude, size, compensation structure. Based on responses from 139 CFOs they find that the model globally explains the intentions of fraudulent reporting and that attitude and size are the main drivers of fraud. Further, Carpenter and Reimers (2005) find, with a survey analysis and an experiment, that the theory of planned behavior can help explain unethical and fraudulent
financial reporting. Almer et al. (2003) use the TPB (without explicitly testing for it) to understand factors that lead to the adoption of flexible work arrangements. Fraud triangle and theory of planned behavior Carpenter and Reimers (2005), in their paper above-mentioned, which applied the TPB or TRA to the prediction of fraudulent reporting, did not use the fraud triangle in their design. In this paper, we relate the TPB to the fraud triangle to explain fraud behavior. Figure 1 details the relationship between the two theories. The “attitudes/rationalizations” component of the fraud triangle can be related to the “attitudes” component of the TPB. In fact, the “attitude” component of the fraud triangle, which, more precisely includes “attitude, character and set of ethical values” (see below), is closely related to “moral norms” (or “moral obligation”) which can be considered as an additional determinant of intentions in situations where ethical behavior is involved (Ajzen 1991, p. 199; Hess 2007, p. 1785-1786). In addition to one’s own moral belief system, these moral obligations can come from laws, professional code or ethics, and other similar sources. Researchers have included this determinant in empirical studies: most find it as a useful addition to the model, but some find that moral obligation functions primarily as an additional determinant of a person’s attitude (Hess 2007, p. 1786). The second component of the fraud triangle, the “incentives/pressures” has a link to the “subjective norms” of the TPB while the third component “opportunities” constitute one part of the “perceived behavioral control”. Given the close relationship between the fraud triangle and the TPB, as demonstrated in Figure 1, we will jointly use both theories in the rest of this article. We label this association “FT/TPB” (for “fraud triangle/theory of planned behavior applied to fraud”).
Insert Figure 1 About Here
In this study, we are interested in morals and ethics, mainly at the individual level. The individual’s role is relevant because as noted by Sauer (2002, p. 956), a company engages in financial fraud only if its reasons for doing so are consonant with the specific motivations of the individuals who control its reporting process. Further, Hess (2007, p. 1787) writes that the studies which have used the TPB to explain unethical behavior have found that the determinant, that has the greatest impact on intentions is attitude (see, e.g., Carpenter and Reimers 2005). Previous
studies also show that auditors generally perceive “attitude” factors to be more important warning signs of fraud than “situational” factors (Heiman-Hoffman et al. 1996). Attitude, morals and ethics in real-life cases of corporate scandals Research questions Based on the above literature review and the increasing concern about attitudes/rationalizations factors into corporate fraud detection auditing guidelines, we will examine two research questions (RQ). RQ1: Can the fraud triangle/theory of planned behavior (FT/TPB) framework be applied to explain ex-post alleged or acknowledged fraud cases? RQ2: If the FT/TPB framework is validated, are the new auditing regulations comprehensive enough to effectively aid fraud detection? Sampling and research design Unlike previous literature (namely Carpenter and Reimers 2005; Gillett and Uddin 2005), we do not work on managers’ intentions but on real behaviors. We examine 39 cases of corporate scandals, using evidence taken from press articles. Media’s role as a monitor for accounting fraud has been recently studied (Miller 2006; Dyck et al. 2007). It has been shown that the press is important due to the pressure it places on management (Dyck et al. Forthcoming). Two main roles are fulfilled by the press. First of all, by rebroadcasting information from other intermediaries (auditors, analysts, lawsuits), the press seems to play an important role by attracting the attention of institutions that may take actions (e.g., regulatory bodies, consumer groups, investment funds) (Dyck et al. Forthcoming). Second, the press can issue new information by undertaking original investigation and analysis. Miller (2006) has shown a negative reaction of markets after the issuance of reporter investigation, which suggests that the press plays an important role as an independent monitor or information intermediary in financial markets. To design our sample, we started from the Corporate Scandal Fact Sheet6, which includes a list of 61 short vignettes on companies. We deleted from this list several companies which are linked to other companies involved in different scandals: accounting firms (e.g., Andersen, KPMG) and banks (e.g., Citigroup, Morgan Stanley). We also withdrew from the list companies with no data available on the personality of the managers (e.g., Cornell). Finally, we added three 10
companies which do not appear in the Corporate Scandal Fact Sheet but had received a lot of adverse publicity (AIG, Delphi and Freddie Mac). The resulting sample includes 39 companies. For the sake of comparability in interpretation, we only used U.S. cases. However, we included Royal Ahold, although it is a Dutch group, because the corporate scandal was mainly based on its U.S. subsidiary – U.S. Food Service. To evaluate the research questions, we searched for evidence from the financial press in the Factiva7 database. SEC documents8 listed in Appendix 2 were not directly used to fill Table 1 but only to understand the technical and accounting aspects of the corporate fraud. For some companies9, we also used the GAO report (United States General Accounting Office 2002) on restatements. Table 1 isolates the three main influences known to be indicators of corporate fraud according to the fraud triangle and the TPB: -
Attitudes/Rationalizations. To enhance reliability, two different researchers analyzed separately the same press articles
on a sample of 10 cases. The major issue was the extraction of the relevant pieces of information from the articles and the allocation of these pieces of information to the four columns of table 1: incentives, opportunities, attitudes and rationalizations. The result was a 95% rate of convergence which indicates that the coding showed strong signs of reliability. The only source of divergence arose because the pressure from analysts is mentioned in two different examples of the appendices of SAS 99: in the incentives/pressures, § 2.1 (see Appendix 1) mentions the “Excessive pressure … to meet the requirements or expectations of third parties due to … trend level expectations of … analysts” while, in the “attitudes/rationalizations” section of SAS 99, § 5 refers to “a practice by management of committing to analysts … to achieve aggressive or unrealistic forecasts”. An examination of the two paragraphs suggests that the first one refers to the pressure exerted by analysts while the second one deals with the attitude of the managers to commit to or to accept this pressure. After resolving this issue, all the other cases were coded by one researcher and five cases were checked randomly by a second researcher, with no apparent problem. Finally, for the sake of transparency and replicability, we provide in Appendix 2 the references of press articles and SEC documents used for each case study.
The numbers displayed after each element of Table 1 refer to the “examples of risk factors” provided in SAS 99 and ISA 240 (see Appendix 1). We find that the two last components (which correspond to the third part of the fraud triangle and the TPB) that are heavily related to morals and ethics are present in all the cases.
Insert Table 1 About Here
Analysis of the results Examining Table 1 we observe that the column “incentives/pressures” and “opportunities” are fully filled with components found in promulgated auditing standards (SAS 99 and ISA 240). In other terms, the elements “subjective norms” and “perceived behavioral control” of the TPB, which corresponds to the first two columns of Table 1, are systematically present in the case of frauds. As the focus of the study is on the attitude factor, we will focus on the “attitudes/rationalizations” component which is split in two, given the different nature of “attitudes” and “rationalizations”. Recall that the component “attitudes/rationalizations” correspond to the element “attitude toward the fraud” of the TPB (see Figure 1). In conclusion, the very fact that all the columns of Table 1 are filled with anecdotal evidence suggests support for the TPB (RQ1). Interestingly, several examples noted in the auditing standards are found in the case studies: -
§ 4 (SAS 99 and ISA 240): “Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend”: represented by stock options (Ahold, AIG, AOL, Bristol-Myers Squibb, Computer Associates, Freddie Mac, Halliburton, Peregrine Systems, WorldCom and Xerox), and the fluctuations on company’s stock price (AIG). This evidence is in line with Coffee (2005) who states that “when one pays the CEO with stock options, one creates incentives for short-term financial manipulation and accounting gamesmanship” (p. 202). Several empirical studies have confirmed the role of stock options as incentives in cases of restatements (Efendi et al. 2007) or securities fraud allegations (Denis et al. 2006). In the same vein, Cheng and Warfield (2005) found that corporate managers with equity incentives engage more frequently in earnings management and Bergstresser and Philippon (2006) document that earnings management is more pronounced at firms where the CEO’s 12
potential total compensation is more closely tied to the value of stock and option holdings. Our evidence is not surprising, given that all our sample-firms are from the U.S., with one exception (see above the description of the sample) and given the explanation given by Coffee (2005) on the importance of stock options in the composition of compensation in the United States. -
§ 5 (SAS 99 and ISA 240): “A practice by management of committing to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts” (Adelphia Communications, Network Associates).
§ 9 (ISA 240): “The owner-manager makes no distinction between personal and business transactions”. Interestingly, we found several instances of the use of personal expenses paid for by the company’s resources (Cendant, Enron, Global Crossing, HealthSouth, K-Mart, Phar-Mor, and Tyco). However, several explanations we found to explain the fraud behaviors are not present in the
auditing standards (see RQ2). We can group them in the categories mentioned in Table 2. Insert Table 2 About Here Finally, the “rationalizations” element is not present in all cases. When we identified it, the major argument put forward by managers is the help they gave to other people or organizations via, e.g., charitable causes (Adelphia Communications, Computer Associates, Enron, Freddie Mac, HealthSouth, and WorldCom) or the idea of acting for the good of the company (Ahold). Discussion and conclusion Our article firstly provides evidence that the analytical framework we use (the FT/TPB) is relevant when matched with cases of corporate frauds (RQ1). However, our findings related to RQ2 (the comprehensiveness of auditing standards) are much more mitigated. Although we acknowledge that, in line with SAS 99, risk factors reflective of attitudes/rationalizations by board members, management, or employees, that allow them to engage in and/or justify fraudulent financial reporting, may not be susceptible to observation by the auditor, we should recall that, as stated by SAS 99 (p. 47), “the auditor who becomes aware of the existence of such information should consider it in identifying the risks of material misstatement arising from fraudulent financial reporting”. Our results are consistent with and reinforce this statement. Based on our analysis, economic motivations (“incentives”) exist in almost all companies. But not all managers enter in corporate 13
fraud. The psychological aspects and the existence of opportunities play an important role in explaining the fraud. Consequently, the auditing regulation should be extended to better integrate the attitudes component. SAS 99 should include more examples of ethical behavior and ISA 240 should also be modified because many examples we found are not covered properly by this standard. Our study is not the first to stress the incompleteness of auditing standards. Loebbecke et al. (1989, p. 4) explain that in their previous work (Loebbecke and Willingham 1988) where they applied the equivalent of the fraud triangle to fraud cases as identified by the SEC, they found some inaccuracy and incompleteness in the SAS list [of risk factors]. However, this survey was based on SAS 53 and our research uses the SAS 99. Although the auditing standards have been improved over time, as mentioned earlier, there is still some room for improvement. Further, the auditors should also better integrate the attitudes component and the press is a good tool to understand the managers’ personality. Thus, our exploration of fraud cases reinforces the conclusion of Martin (2007) who addresses the demand for auditors to assess the integrity and ethical values of clients. This is already part of the control environment audit mandated by SOX 404. The audit requires auditors to evaluate controls via a framework such as COSO which lists management control philosophy as an important element of the control environment. Auditors should place special emphasis on evaluating the ethics of individuals through the assessment of the attitudes, a component of the fraud triangle and of the TPB (see Figure 1). Our study is also consistent with past research (Gillett and Uddin 2005) which highlighted the importance of questionnaires, although Pincus (1989) found mixed results concerning the efficacy of red flags questionnaires, and automated decision aids to improve the auditor’s ability to detect fraud. This article is in line with Jennings (2006b, 2006a) who identifies “seven signs of ethical collapse”, which we can classify into the three dimensions of the fraud triangle and the TPB: (1) incentives (“sign 1: Pressure to meet numbers”), (2) opportunities (“sign 4: A weak board”, “sign 5: Conflicts of interest”) and (3) incentives/rationalizations (“sign 2: Fear and silence”, “sign 3: Sycophantic executives and an iconic CEO”, “sign 6: Over-confidence”, “sign 7: Social responsibility is the only measure of goodness”). The advantage of the TPB is that it allows auditors, researchers and regulators to understand the role that the elements underlying the attitude play in perpetuating fraud. For example, using
Ajzen’s (1991) methodology, auditors can look at the perception managers have of the consequences of committing fraud and the perceived likelihood that managers have that these consequences will occur. Further, other elements of the TPB can be examined as well. For example, auditors may look at the role of important referents on influencing (or not) a manager to commit fraud. Auditors must also place emphasis on evaluating the organizational culture. As explained by Carpenter and Reimers (2005, p. 118), attitudes for managers can be shaped by the firm’s culture and direction of top executives and the board of directors. This view is also supported by the work of Kemmerer and Shawver (2007). They argue that the responsibility for ethical behavior rests upon the organization and the organizational values. Thus, a person may be more likely to behave unethically if the perceived consequences will not be punished but rewarded (Carpenter and Reimers 2005, p. 118). Our article is also in line with Cohen et al.’s works on perceived fairness (2007). Auditors should evaluate the fairness of the work climate. For example, are some employees overworked or ill compensated? If so, this situation could lead to resentment and possible cheating. Finally, an important limitation of our results arises from the absence of automatic reciprocity of the red flags we identified from the financial press and the commitment of corporate fraud. All the managers who have a high standard of living and have been identified as high-profile leaders will not hopefully engage in fraudulent acts. However, we still believe that the existence of these red flags is a relevant indicator of a potential fraud. Cooper (2008), in the book telling her story as the WorldCom’s whistleblower, explains that the accountants who accepted the order to record the fraudulent entries took into consideration the personality of the managers to rationalize their behavior: “Troy [one of the involved accountants] wonders if maybe he’s making too much out of this. After all, Scott [the CFO]’s very smart and highly regarded. He must know what he’s doing” (p. 7). In this example, the fact that the CFO was considered as a “financial wizard”, if it did not generate a fraudulent behavior per se, played a major role in the “rationalization” phenomenon by the accountants pushed to behave fraudulently. Future research In the field of psychology and behavior, evidence is not always easily objective, especially if we consider the main topic of our study: corporate fraud. However, our analysis is based on quotes from the involved managers, which represent a first level of evidence and, more generally, 15
on press articles which constitute a second level of evidence. We found an extensive number of press articles on the studied cases, and no case of inconsistency among the articles, which is a sign of reliability of the sources used in this study. A future study can explore different qualitative methods to ascertain the reliability and objectivity of these sources. In line with Choo and Tan (2007), we are aware of the relatively weak evidence provided by anecdotal elements as we use case studies. However, even if the sample of case studies we investigate is not comprehensive, this sample has allowed us to identify potential gaps in auditing regulation. In our analysis, we have granted an equal weight to the three components of the Fraud Triangle and TPB: incentives, opportunities and attitudes. In real life, we believe this is a matter of equilibrium between the three components. When the weight of the economic motivations is too high, the ethical threshold decreases, and vice versa. When it is very easy to commit a fraud (numerous opportunities), the probability to find a fraud is high. One area of future research would be to investigate the related weight of each component. Finally, for the sake of simplicity and consistency, we focused on U.S. cases of alleged or acknowledged corporate frauds. However, fraud is of course not limited to the U.S. and many countries have faced similar situations. It would be interesting to extend the scope of study to non-U.S. companies (e.g., Parmalat 10 – Italy –, Shell 11 – U.K./Netherlands, Marionnaud 12 – France, etc.).
Appendix 1: Comparison SAS 99 – ISA 240: Risk Factors Relating to Misstatements Arising from Fraudulent Financial Reporting The following elements are examples of risk factors relating to misstatements arising from fraudulent financial reporting. They are taken from SAS 99 and ISA 240. We display both classifications: letters in SAS 99 and figures in ISA 240. The figures in italics have been added by ourselves for a better reference to the examples in Table 1.
a./1. 1.1 1.2 1.3 1.4 1.5 1.6 1.7 b./2. 2.1
2.2 2.3 2.4 c./3.
SAS 99 ISA 240 Incentives/Pressures Financial stability or profitability is threatened by economic, industry, or entity operating conditions, such as (or as indicated by) the following: High degree of competition or market saturation, accompanied by declining margins. High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates. Significant declines in customer demand and increasing business failures in either the industry or overall economy. Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover imminent. Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth. Rapid growth or unusual profitability especially compared to that of other companies in the same industry. New accounting, statutory, or regulatory requirements. Excessive pressure exists for management to meet the requirements or expectations of third parties due to the following: Profitability or trend level expectations of investment analysts, institutional investors, significant creditors, or other external parties (particularly expectations that are unduly aggressive or unrealistic), including expectations created by management in, for example, overly optimistic press releases or annual report messages. Need to obtain additional debt or equity financing to stay competitive, including financing of major research and development or capital expenditures. Marginal ability to meet exchange listing requirements or debt repayment or other debt covenant requirements. Perceived or real adverse effects of reporting poor financial results on significant pending transactions, such as business combinations or contract awards. Information available indicates that management or Information available indicates that the personal the board of directors’ personal financial situation is financial situation of management or those charged threatened by the entity’s financial performance with governance is threatened by the entity’s arising from the following: financial performance arising from the following: -
Significant financial interests in the entity. Significant portions of their compensation (for example, bonuses, stock options, and earn-out arrangements) being contingent upon achieving aggressive targets for stock price, operating results, financial position, or cash flow. Personal guarantees of debts of the entity. There is excessive pressure on management or There is excessive pressure on management or operating personnel to meet financial targets set up operating personnel to meet financial targets by the board of directors or management, including established by those charged with governance, sales or profitability incentive goals. including sales or profitability incentive goals.
a./1. 1.1 1.2
1.3. 1.4 1.5 1.6 1.7 b./2. 2.1 2.2
c./3. 3.1 3.2 3.3 d./4. 4.1 4.2 4.3
SAS 99 ISA 240 Opportunities The nature of the industry or the entity’s operations provides opportunities to engage in fraudulent financial reporting that can arise from the following: Significant related-party transactions not in the ordinary course of business or with related entities not audited or audited by another firm. A strong financial presence or ability to dominate a certain industry sector that allows the entity to dictate terms or conditions to suppliers or customers that may result in inappropriate or non-arm’s length transactions. Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate. Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions Significant operations located or conducted across international borders in jurisdictions where differing business environments and cultures exist. Use of business intermediaries for which there appears to be no clear business justification. Significant bank accounts or subsidiary or branch operations in [tax haven] jurisdictions for which there appears to be no clear business justification. There is ineffective monitoring of management as a result of the following: Domination of management by a single person or small group (in a non owner-managed business) without compensating controls. Ineffective board of directors or audit Ineffective oversight by those charged with committee oversight over the financial governance over the financial reporting reporting process and internal control. process and internal control. There is a complex or unstable organizational structure, as evidenced by the following: Difficulty in determining the organization or individuals that have controlling interest in the entity. Overly complex organizational structure involving unusual legal entities or managerial lines of authority. High turnover of senior management, legal High turnover of senior management, legal counsel, or board members. counsel, or those charged with governance. Internal control components are deficient as a result of the following: Inadequate monitoring of controls, including automated controls and controls over interim financial reporting (where external reporting is required). High turnover rates or employment of ineffective accounting, internal audit, or information technology staff. Ineffective accounting and information Ineffective accounting and information systems, including situations involving systems, including situations involving reportable conditions. material weaknesses in internal control.
1 2 3
4 5 6
7 8 9 10 11 12 12.1 12.2 12.3
SAS 99 ISA 240 Attitudes/Rationalizations Ineffective communication, implementation, support, or enforcement of the entity’s values or ethical standards by management or the communication of inappropriate values or ethical standards. Nonfinancial management’s excessive participation in or preoccupation with the selection of accounting policies or the determination of significant estimates. Known history of violations of securities laws or Known history of violations of securities laws or other laws and regulations, or claims against the other laws and regulations, or claims against the entity, its senior management, or board members entity, its senior management, or those charged with alleging fraud or violations of laws and regulations. governance alleging fraud or violations of laws and regulations. Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend A practice by management of committing to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts. Management failing to correct known reportable Management failing to correct known material conditions on a timely basis. weaknesses in internal control on a timely basis. An interest by management in employing inappropriate means to minimize reported earnings for taxmotivated reasons. Low morale among senior management. The owner-manager makes no distinction between personal and business transactions. Dispute between shareholders in a closely held entity. Recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality. The relationship between management and the current or predecessor auditor is strained, as exhibited by the following: Frequent disputes with the current or predecessor auditor on accounting, auditing, or reporting matters. Unreasonable demands on the auditor, such as unreasonable time constraints regarding the completion of the audit or the issuance of the auditor’s report. Formal or informal restrictions on the auditor Formal or informal restrictions on the auditor that inappropriately limit access to people or that inappropriately limit access to people or information or the ability to communicate information or the ability to communicate effectively with the board of directors or audit effectively with those charged with committee. governance. Domineering management behavior in dealing with the auditor, especially involving attempts to influence the scope of the auditor’s work or the selection or continuance of personnel assigned to or consulted on the audit engagement.
Appendix 2: References of press articles and SEC documents13 used for the case studies Adelphia Communications Jennings, M. M.: 2006, ‘The seven signs of ethical collapse’, European Business Forum 25(Summer), 32-38. Michel, L.: 2002, ‘Rigas, in interview, laments failing the ordinary people’, Buffalo News, June 30, A1. Michel, L.: 2002, ‘Rigas confident of vindication’, Buffalo News July 30, A1. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17627 - Accounting and Auditing Enforcement Release No. 1599’, July 24. Ahold McCartney, R.J.: 2003, ‘Food baron’s fall shakes Dutch; ‘Superman’ CEO leaves Ahold empire in jeopardy’, The Washington Post March 1, A1. SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18929 - Accounting and Auditing Enforcement Release No. 2124’, October 13. AIG Kadlec, D.: 2005, ‘Down... But not out prosecutors are swarming around him, but Hank Greenberg is as focused as ever--and not giving an inch. How he rose so far and fell so fast’, Time June 20, 50. Murray, A.: 2005, ‘Greenberg lost sight of the long view’, The Wall Street Journal June 22, A2. SEC (Securities and Exchange Commission): 2006, ‘Litigation Release No. 19560 - Accounting and Auditing Enforcement Release No. 2371’, February 9. Starkman, D.: 2005, ‘Greenberg Accused Of ‘Self-Dealing’; Charity Hurt by Stock Sale, Spitzer Says’, The Washington Post, December 15, D03. Stoll, I.: 2005, ‘Greenberg lashes out at Spitzer, defends his role at foundation, AIG’, The New York Sun December 16. AOL Anonymous:2003, ‘AOL and Time Warner executives accused of pocketing nearly $1 Billion in insider trading; Media giant inflated stock prices with “tricks, contrivances and bogus transactions” while top executives hastily cashed in their shares for personal profits’ Ascribe News April 13. Loomis, C.J.: 2003, ‘Why AOL’s accounting problems keep popping up; The online giant created ad “revenues” out of thin air. Now, it’s got scandals!’, Fortune, 147(8), 85. Maccoby, M.: 2003, ‘The narcissist-visionary; learning to love your difficult boss’, Forbes Magazine 171(05), 36. SEC (Securities and Exchange Commission): 2005, ‘Litigation Release No. 51400 - Accounting and Auditing Enforcement Release No. 2215, March 21. Bristol-Myers Squibb Countryman, A.: 2004, ‘False profits lead corporate insiders to riches’, Chicago Tribune September 5. Dash, E.: 2004, ‘Bristol-Myers agrees to settle accounting case’, The New York Times August 5. Harris, G.: 2003, ‘Will the pain ever let up at Bristol-Myers?’, The New York Times May 18, 1. Krauskopf, L.: 2005, ‘2 are charged in coverup of Bristol-Myers fiscal ills’, The Record June 16, A01. Lavelle, L.: 2003, ‘Making CEOs pay for bogus books’, Business Week October 16. SEC (Securities and Exchange Commission): 2004, ‘Complaint – U.S. District Court’, August 4. Taub, S.: 2003, ‘Bitter pill? Bristol-Myers squibb off by $900 Million’, CFO.com March 11. Todd, S. and G.E. Jordan: 2005, ‘Terms of employment - CEO Peter Dolan survives indictment of Bristol-Myers Squibb, but he must give up chairman’s title and meet conditions’, The Star Ledger June 16, 51. Winter, G. and R. Abelson: 2002, ‘The optimist leading Bristol-Myers’, The New York Times, May 12, 1. Cendant Lubanko, M.:2004, ‘Cendant Executives to Be Placed on Trial for Accounting Fraud’, The Hartford Courant (KRTBN), May 7. Barrett, A.:1998, Cendant: Who’s to blame? A loose accounting culture may lie at the core of the debacle Business Week, August 17, 70. Nelson, E.:1998, ‘Cendant dismisses a senior finance aide --- Ex-CUC executive denies knowing irregularities existed in accounting’, The Wall Street Journal, April 20, A3.
Morgenson G. :2004, ‘Before Enron, there was Cendant’, The New York Times May 9. SEC (Securities and Exchange Commission): 2001, ‘Litigation Release No. 16910 - Accounting and Auditing Enforcement Release No. 1372’, February 28. Computer Associates Alphonso C.: 2000, ‘A man of apparent contradictions - Software tycoon devoted to charities’, The Globe and Mail, August 8, B9. Anonymous: 2000, ‘Accept tech as a part of business’, Business Times Singapore April 24. Eltman F.: 2006, ‘As Kumar spoke of reform, crimes had already been committed’, Associated Press Newswires, April 29. SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18665 - Accounting and Auditing Enforcement Release No. 1988, April 8. Svensson P.: 2000, ‘Computer Associates CEO steps down’, Associated Press online, August 7. CMS Energy Irwin J.: 2002, ‘CMS Energy CEO resigns amid bogus `round-trip’ energy trades’, Associated Press, May 24. Barber, J.: 2002, ‘US attorneys enter trading probe of CMS signals expansion of wash-trading investigation’, Platts Oilgram News 80(101). SEC (Securities and Exchange Commission): 2004, ‘Accounting and Auditing Enforcement Release No. 1978’, March 17. Datek Online Barboza, D., 1998: ‘He’s dazzled Wall Street, but the ghosts of his company may haunt his future’, The New York Times May 10, 1. Nelson, J., W.T. Quinn, S. Goldstein, M. McKnight et al.: 2004, ‘Forty under 40: success at an early’, NJBIZ 17(9), 12. SEC (Securities and Exchange Commission): 1999, ‘Administrative proceedings No. 3-9901’, May 18. Delphi Rebello, J.:2006, ‘Delphi: Ejecting Deloitte & Touche would delay ‘05 audit’, Dow Jones Corporate Filings Alert January 4. Byron, C.: 2005, ‘Oracle at Delphi - Parts maker’s fate carries grave consequences’ New York Post November 14, 33. Shepardson, D.: 2006, ‘Ex-Delphi execs face civil fraud charges; SEC says top financial officers used accounting schemes to hide supplier’s troubled finances’, The Detroit News October 19, 1. Barkholz, D.: 2006, ‘Delphi: A tale of fear, fast money; Feds: Improper accounting over warranty claims led to fraud case’, Automotive News 81(6228), 1. SEC (Securities and Exchange Commission): 2006, ‘Litigation Release No. 19891 - Accounting and Auditing Enforcement Release No. 2504’ October 30. Dollar General Albright, M.: 2002, ‘Strong dollar’, St. Petersburg Times 1H, June 30. Chad Terhune, C. and Lublin J.S.: 2002, ‘Unlike others, Dollar General issues a mea culpa --- Amid Enron, other scandals, discount retailer apologizes for its accounting problems’, The Wall Street Journal January 17, B1. Phred Dvorak, P. and Badal, J.: 2006, ‘Relative problems --- Boards of family businesses grapple with how to sack executives who are kin’, The Wall Street Journal B1, July 24. Duke Energy Anonymous: 2004, ‘Former Duke executives latest charged on trading; aim said to be personal gain’, Power Markets Week, April 26, 7. Anonymous: 2005, ‘Trial casts accused traders as crooks, victims’, Megawatt Daily, 10(166), 9. Choe, S.: 2004, ‘Three former Duke Energy employees indicted for bogus trading scheme’, The Charlotte Observer, April 22. SEC (Securities and Exchange Commission): 2005, ‘Securities Exchange Act of 1934 Release No. 51995 Accounting and Auditing Enforcement Release No. 2273’ July 8.
Dynegy Alvey, J.: 2002, ‘Strategy gurus: Managing under chaos’, Public Utilities Fortnightly 140(11), 50. Lublin, J.S.: 2005, ‘CEO compensation survey (A special report) --- Goodbye to pay for no performance: Companies have long paid lip service to the idea of "pay for performance;" Now they’re getting really serious’, The Wall Street Journal R1, April 11. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17744 - Accounting and Auditing Enforcement Release No. 1632’ September 25. El Paso Corporation Anonymous: 2001, ‘FERC judge: “Prima facie” case of El Paso affiliate abuse’, Dow Jones Energy Service August 6. Anonymous: 2001, ‘FERC sets market issues for hearing but upholds El Paso merchant deal’, Inside F.E.R.C. April 2, 1. JM: 2002, ‘Wyatt suit alleges El Paso “wash” trades’, Gas Daily, 19(226), 1. Ryser, J.: 2002, ‘El Paso faces new detailed allegations on wash trading, mark-to-market abuse’, Power Markets Week November 25, 1. SEC (Securities and Exchange Commission): 2007, ‘Litigation Release No. 19991’ February 7. Enron Anonymous: 2002, ‘The saga of Andrew Fastow’, The Washington Post August 3, A18. Saporito, B.: 2002: ‘Speak no evil; Andrew Fastow built a reputation as Enron’s financial wizard. though he’s refusing to testify, it’s clear he was in over his head’, Time 159(7), 34. Zellner, W.: 2002, ‘The man behind the deal machine as creator of iffy Enron partnerships, ousted CFO Andrew Fastow is a prime target for investigators’, Business Week February 4, 40. SEC Enron-related enforcement actions (see http://www.sec.gov/spotlight/enron.htm). Freddie Mac Anonymous: 2003, ‘Freddie report: ‘Steady Freddie’ tone came from Brendsel’, Dow Jones International News July 23. Caplan, J.: 2003, ‘SEC alleges former CEO, CFO, artificially boosted revenue, deceived outside auditor’, CFO.com, July 23. Day, K.: 2003, ‘Report faults Freddie Mac officials; Board says firm’s culture led to transactions that forced restatements’, The Washington Post July 24, E1. Jones, D.: 2003, ‘Friends say ousted Freddie Mac exec is a straight arrow; David Glenn was fired in accounting investigation’, USA Today, June 24, B01. SEC (Securities and Exchange Commission): 2007, ‘Litigation Release No. 20304 - Accounting and Auditing Enforcement Release No. 2728’ September 27. Weil, J.: 2003, ‘Freddie Mac’s charity case --Conflict-of-interest questions stem from ex-auditor’s role at recipient of largesse’, The Wall Street Journal July 21, C1. Wigfield, M.: 2003, ‘Colleagues puzzled by picture of ex-Freddie Mac exec’, Dow Jones News Service, June 18. Global crossing Creswell, J. and Prins, N.: 2002, ‘The Emperor of greed; With the help of his bankers, Gary Winnick treated Global Crossing as his personal cash cow--until the company went bankrupt’, Fortune, 145(13), June 24, 106. Creswell, J.: 2001, Global Flameout; Chairman Gary Winnick spent like a Roman emperor. But the fall of muchhyped Global Crossing spells trouble for other telcos too’, Fortune, 144(13), December 24, 109. SEC (Securities and Exchange Commission): 2005, ‘Accounting and Auditing Enforcement Release No. 2231’ April 11. Stremfel, M. and Palazzo, A.: 2002, ‘Rise and fall of Global pipe dream’, Los Angeles Business Journal 24(7), February 18, 1. Halliburton Anonymous: 2002, ‘A legal watchdog group files suit against Halliburton and vice president Dick Cheney after Wolf Haldenstein Adler Freeman and Herz LLP commenced class action suit against Halliburton Company and Arthur Andersen, LLP on behalf of Halliburton shareholders’, PR Newswire, July 12. MacLaren, L.: 2002, ‘Now he’ll have to come out of hiding’, The Herald, July 13, 15.
Madsen, W.: 2000, ‘Cheney at the helm: at Halliburton, oil and human rights did not mix’, The Progressive 64(9), September 1, 21. Marlantes, L.: 2002, ‘Cheney’s CEO past as burden; vice president still campaigns for GOP, but his corporate past poses risks for party’, Christian Science Monitor, July 30, 1. SEC (Securities and Exchange Commission): 2004, ‘Securities Exchange Act Of 1934 Release No. 50137 – Litigation Release No. 18817 - Accounting and Auditing Enforcement Release No. 2072’ August 3. SEC (Securities and Exchange Commission): 2007, ‘Litigation Release No. 20104 - Accounting and Auditing Enforcement Release No. 2606’ May 3. Harken Energy Coile, Z.: 2002, ‘Story changes on Bush stock sale - Past business deal haunts president as he plans Wall Street speech’, The San Francisco Chronicle July 4, A1. Halkias, M.: 1992, ‘Bare-bones Harken lays low: Troubled company puts faith in Bahrain wells’, The Dallas Morning News June 28, 1H. Sablatura, B.: 1994, ‘Campaign ‘94: George W. Bush - Wealth produced via stock swaps and bailouts’, Houston Chronicle May 8, 10. Zeleny, J.: 2002, ‘Bush stock trading gets new scrutiny - White House defends filings in 1990’, Chicago Tribune, July 4. HealthSouth Haddad, C.: 2003, ‘Too good to be true - Why HealthSouth CEO Scrushy began deep-frying the chain’s books’, BusinessWeek April 14, 70. Maich, S.: 2002, ‘If you hide fraud well enough, auditors will miss it: HealthSouth charged’, Financial Post March 21, IN1. Morgenson, G. and Freudenheim, M.: 2003, ‘Scrushy ran HealthSouth real estate on the side’, The New York Times April 14, 1. Schneider, G.: 2003, ‘Scrushy’s sterling image tarnished; Community’s faith in HealthSouth CEO tested’, The Washington Post April 9, April 18, E01. SEC (Securities and Exchange Commission): 2003, ‘Litigation Release No. 18044 - Accounting and Auditing Enforcement Release, No. 1744, March 20. Tomberlin, M.: 2003, ‘Trappings of wealth - CEO may have wanted the good life a little too much’, The Star-Ledger March 27, 57. Homestore.com Krantz, M.: 2002, ‘Homestore’s former CEO under scrutiny; Investigators suspect ruse too big for Wolff not to know’, USA Today, November 18, B.03. Murray, M.: 2002, ‘Homestore hit with securities fraud charges’, Real Estate Finance Today, The Electronic Edition, January 14, 2. Palmeri, C.: 2002, ‘Homestore.com: A real fixer-upper; The real estate site’s new CEO, Michael Long, faces an intimidating list of repairs, from an accounting mess to shareholder suits’, Business Week Online, January 15. SEC (Securities and Exchange Commission): 2003, ‘Accounting and Auditing Enforcement Release No. 1865’, September 22. SEC (Securities and Exchange Commission): 2006, ‘Litigation Release No. 19904 - Accounting and Auditing Enforcement Release No. 2512, November 8. HPL Technologies Byron, C.: 2002, Cooking with PwC - How does an auditor miss $25m in fake sales? New York Post, July 29, 31. Ostrom, M.A.: 2002, ‘Accusers charge former chief of HPL Technologies with fraud’, San Jose Mercury News September 11. Ostrom, M.A.: 2002, ‘Mind-boggling accounting fraud at San Jose, Calif., firm stuns tech industry’, San Jose Mercury News, August 18. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17716 - Accounting and Auditing Enforcement Release No. 1625’ September 10.
ImClone Systems Anand, G., Markon, J. and Adams, C.: 2002, ‘Biotech bust: ImClone’s Ex-CEO arrested, charged with insider trading - Prosecutors say Waksal family sold $9 million in stock before cancer-drug ruling - Martha Stewart’s holiday sale’, The Wall Street Journal, June 13, A1. Barrett, D.: 2002, ‘Ex-ImClone CEO indicted for fraud’, AP Online, June 12. Barrett, D.: 2002, ‘Former ImClone CEO Sam Waksal was a very social scientist’, Associated Press Newswires June 26. Clarke, T.: 2002, ‘ImClone ex-CEO Waksal charged with insider trading’, Reuters News, June 12. SEC (Securities and Exchange Commission): 2003, ‘Litigation Release No. 18408’ October 10. K-Mart Anonymous: 2002, ‘Kmart Chief Executive Officer leaves company’, Detroit Free Press, March 11. Anonymous: 2003, ‘Kmart probe faults former executives - Improper travel, salaries uncovered’, Detroit Free Press, January 25. Hays, C.L.: 2003, ‘Kmart accuses former officials of misconduct’, The New York Times January 25, 1. SEC (Securities and Exchange Commission): 2005, ‘Complaint’, August 23. Lucent Burns, J.: 2004, ‘Lucent to pay $25 mln to settle SEC acctng fraud case’, Dow Jones News Service May 17. May, J.: 2004: ‘SEC accuses 10 of fraud at Lucent - Accounting maneuvers allegedly overstated firm’s sales by more than $1B’, The Star-Ledger May 18, 1. SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18715 - Accounting and Auditing Enforcement Release No. 2016’, May 17. Merck Anonymous: 2002, ‘Merck booked $12.4 bln in revenue it never collected’, Dow Jones Energy Service, July 08. Brubaker, B.: 2002, ‘Merck’s accounting questioned; Co-payments were booked as revenue’, The Washington Post, July 09, E01. MicroStrategy Anonymous: 2000, ‘MicroStrategy revises timing of revenue recognition’, PR Newswire, March 20. Barrett, L.: 2001, ‘MicroStrategy starts war with shorts, but enemy’s within’, [email protected]
Investor from ZDWire, April 20. Hilzenrath, D.S.: 2001, ‘MicroStrategy auditor to settle investor suit; Accounting giant to pay $55 million’, The Washington Post May 9, A1. Leibovich, M.: 2002, ‘MicroStrategy’s CEO sped to the brink’, The Washington Post January 6, A01. Leibovich, M.: 2002, ‘At the height of a joy ride, MicroStrategy dives’, The Washington Post , January 7, A01. Leibovich, M.: 2002, ‘Once defiant, MicroStrategy chief contritely faces SEC’, The Washington Post January 8, A01, Leibovich, M.: 2002, ‘Maybe an older, wiser visionary; Chastened wonder boy back to business roots’, The Washington Post January 9, A01. SEC (Securities and Exchange Commission): 2000, ‘Litigation Release No. 16829 - Accounting and Auditing Enforcement Release No. 1350,’ December 14. SEC (Securities and Exchange Commission): 2003, ‘Accounting and Auditing Enforcement Release No. 1835’, August 8. Network Associates Ackerman; E. and Kang, C.: 2001, ‘Silicon valley software company sinks under its own ambition’, Knight Ridder Tribune Business News, February 15. SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18986 - Accounting and Auditing Enforcement Release No. 2146,’ November 30. Peregrine Systems Allen, M.; 2002, ‘Peregrine Woes Called ‘Disaster’’, San Diego Business Journal 23(39) September , 1. Bossie, D.N.: 2002, ‘Bill Richardson’s Enron; Was he an ‘outsider’ or an insider at Peregrine?’, The Washington Times, October 01, A19.
Cole, T.J.: 2002, ‘Tenure at Peregrine Haunts Richardson’, Albuquerque Journal, October 27, A1. Peterson, K.: 2002, ‘Peregrine probes test Moores’ corporate character’, The San Diego Union-Tribune, July 28, 1-3. SEC (Securities and Exchange Commission): 2003, ‘Litigation Release No. 18191 - Accounting and Auditing Enforcement Release No. 1802’, June 16. Phar-Mor Abramowitz, M.: 1992, ‘A pillar’s fall shakes Ohio town; Phar-Mor founder’s troubles generate bafflement, worry’ The Washington Post, August 07, F01. Anonymous: 1992, ‘Phar-Mor fires Monus amid charges of fraud’, Chain Drug Review August 10. McCarty, J.F. and Schneider, R.: 1992, ‘Team owner accused in $350 million fraud case’, The Plain Dealer Cleveland, August 05. Nelson, G.: 1994, ‘The rigging of a fraud: Report reveals mechanics of scheme’, Tribune Chronicle January 30. Schroeder, M. and Schiller, Z.: 1992, ‘A scandal waiting to happen - Why did the alleged fraud at Phar-Mor go undetected for so long?’, Business Week August 24, 32. SEC (Securities and Exchange Commission): 1995, ‘Litigation Release No. 14716 - Accounting and Auditing Enforcement Release No. 1802’, November 9. SEC (Securities and Exchange Commission): 1996, ‘Litigation Release No. 14819 - Accounting and Auditing Enforcement Release No. 761, February 16. Wood, A.: 1992, ‘Lawsuit tells how fraud worked’, Business Journal of the Five-County Region, November 15, 3. Wood, A.: 1993, ‘Monus confidant: everyone knew everything’, Business Journal of the Five-County Region, August 15, 3. Qwest Kilzer, L. Milstead, D. and Smith, J.: 2002, ‘Qwest’s rise and fall; Nacchio exercised uncanny timing in selling stock’, Rocky Mountain News, June 03, 1C. SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18936 - Accounting and Auditing Enforcement Release No. 2127, October 21. SEC (Securities and Exchange Commission): 2005, ‘Litigation Release No. 19136 - Accounting and Auditing Enforcement Release No. 2209, March 15. Smith, J., Kilzer, L. Milstead, D. and Accola, J.: 2003, ‘Split decisions; Phil Anschutz rarely seeks the spotlight, but the collapse of the market has illuminated Qwest founder’s overlapping business deals’, Rocky Mountain News February 08, 1C. Smith, J.: 2002, ‘Is troubled Qwest missing Anschutz’s golden touch? Ailing stock, SEC probe and management questions are pulling Qwest’s billionaire founder away from his sports and entertainment empire’, Rocky Mountain News, April 27, 1C. Smith, J.: 2002, ‘Nacchio’s out; Qwest CEO resigns amid company’s financial, regulatory woes’, Rocky Mountain News June 17, 1B. Reliant Energy Banerjee, N.: 2002, ‘Energy Trader Admits Faking Transactions’, The New York Times, May 14, 1. Oldham, C.: 2002, ‘Two executives leave Reliant Resources after energy-trading disclosures’, Dallas Morning News, May 17. SEC (Securities and Exchange Commission): 2003, ‘Securities Exchange Act of 1934, Release No. 47828, May 12. SEC (Securities and Exchange Commission): 2005, ‘Securities Exchange Act of 1934, Release No. 51315, March 3. Rite Aid Corporation Ahrens, F.: 2002, ‘History of conflict for ex-Rite Aid chief; Indictment paints picture of grass as an arrogant bully’, The Washington Post June 22, E1. Carroll, P. and Lyon, E.: 2002, ‘A fortunate son falls to justice’, The Sunday Patriot-News Harrisburg, June 23, A01. Dochat, T.: 2002, ‘Three former Rite Aid executives are indicted, dispute earnings allegations’, The Patriot-News, June 22. Jackson, P.: 2002, ‘Four former and current Rite Aid executives indicted’, Associated Press Newswires, June 21. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17577 - Accounting and Auditing Enforcement Release No. 1581, June 21.
Sunbeam Anonymous: 1998, ‘Al Dunlap - Exit bad guy’, The Economist, June 20. Church, E.: 1998, ‘Chainsaw’s own system cuts him down’, The Globe and Mail June 19, B21. Dobbs, L. and Marchini, D.: 1998, ‘Al Dunlap Talks’, CNNfn: Before Hours, July 09. Manor, R. and Wolinsky, H.: 1998, ‘The legacy of `Chainsaw Al’, Chicago Sun-Times, June 17, 68. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17710 - Accounting and Auditing Enforcement Release No. 1623, September 4. Stewart, C.: 1998, ‘Live by Chainsaw, die by Chainsaw’, The Australian, June 20, 1. Tyco Anonymous: 2004, ‘Suit against Kozlowski, Tyco Subsidiary’s Board to Continue’, Corporate Officers and Directors Liability Reporter, 20(13), December 27. Lin, A.: 2005, ‘Former Tyco executives guilty on most counts; High-profile verdicts could bolster Morgenthau’s reelection prospects; Earlier Tyco acquittal; reputation enhanced’, New York Law Journal June 20, 1. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17722- Accounting and Auditing Enforcement Release No. 1627, September 12. SEC (Securities and Exchange Commission): 2003, ‘Securities Exchange Act of 1934 Release No. 48328 Accounting and Auditing Enforcement Release No. 1839, August 13. Ullico Hamburger, T. and Harwood, J.: 2002, ‘Inside deal: how union bosses enriched themselves on an insurer’s board Their shares of Ullico Inc. suddenly grew valuable amid telecom bubble --A Global Crossing connection’, The Wall Street Journal, April 05, A1. Bernstein, A.: 2002, ‘Labor chieftans’ secret stock deal. Investigations may soon blow the lid off shenanigans at Ullico’, Business Week November 18, 104. Hamburger, T. and Valbrun, M.: 2003, ‘Union chiefs made millions at Ullico’, The Wall Street Journal, April 02, A6. Edsall, T.B.: 2003, ‘Union firm pressured on claims of insider trading; State insurance regulator and AFL-CIO officials seek report on Ullico board members’ alleged profits’, The Washington Post January 21, A04. Waste management Bailey, J.: 1999, ‘Accounting scandal endangers retired Waste Management CEO’s pension’, Dow Jones Business News, May 19. SEC (Securities and Exchange Commission): 2001, ‘Securities Exchange Act of 1934 Release No. 44444 Accounting and Auditing Enforcement Release No. 1405, June 19. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17435 - Accounting and Auditing Enforcement Release No. 1532’, March 26. Weil, J. and Schroeder, M.: 2002, ‘Waste Management suit by SEC zings Andersen’, The Wall Street Journal March 27, C1. WorldCom Brown, T.R.: 2002, ‘WorldCom Inc. says nearly $3.8 billion hidden in its books, CFO fired’, Associated Press Newswires, June 26. Jennings, M. M.: 2006, 'The seven signs of ethical collapse', European Business Forum 25(Summer), 32-38. Latour, A., Young, S. and Yuan, L.: 2005, ‘Held accountable: Ebbers is convicted in massive fraud --- WorldCom jurors say CEO had to have known; unconvinced by Sullivan - Silence and tears in jury room’, The Wall Street Journal, March 16, A1. O’Donnell, J.: 2005, ‘Bernie Ebbers is a man of many contradictions; Stickler for detail or out of touch? He’s an enigma’, USA Today, March 16, B2. Sandberg, J., Blumenstein, R. and Young, S.: 2002, ‘WorldCom internal investigation uncovers massive fraud’, Dow Jones Business News, June 25. SEC (Securities and Exchange Commission): 2002, ‘Accounting and Auditing Enforcement Release No. 1658, November 5. SEC (Securities and Exchange Commission): 2002, ‘Litigation Release No. 17829’, November 1. SEC (Securities and Exchange Commission): 2003, ‘Litigation Release No. 18277 - Accounting and Auditing Enforcement Release No. 1834’, August 7.
SEC (Securities and Exchange Commission): 2004, ‘Litigation Release No. 18605 - Accounting and Auditing Enforcement Release No. 1966, March 2. Warner, J.: 2002, ‘The greed, the fraud, the crash. Another US giant falls to earth’, The Independent – London, June 27, 1. Xerox Anonymous: 2003, ‘The past, present and finally Xerox’ future’, Print action, July. Lear, R.W. and Yavitz, B.: 2001, ‘America’s best & worst boards’, Chief Executive, October , 1, 54. Olive, D.: 2002, ‘Many CEOs richly rewarded for failure - They didn’t suffer as stocks tanked in new economy’, The Toronto Star, August 25, A01. SEC (Securities and Exchange Commission): 2003, ‘Litigation Release No. 18174 - Accounting and Auditing Enforcement Release No. 1796’, June 5. SEC (Securities and Exchange Commission): 2005, ‘Litigation Release No. 19418 - Accounting and Auditing Enforcement Release No. 2333’, October 6. SEC (Securities and Exchange Commission): 2005, ‘Securities Exchange Act of 1934 Release No. 51574 Accounting and Auditing Enforcement Release No. 2234, April 19. SEC (Securities and Exchange Commission): 2006, ‘Litigation Release No. 19573 - Accounting and Auditing Enforcement Release No. 2379’, February 22.
This theory states that “an intense emphasis on monetary success induces corporate executive Fraud”, “corporate executives exploit/disregard regulatory controls to commit Fraud”, and “a corporate environment that is preoccupied with monetary success provides justification/rationalization for success by deviant means such as Fraud”. 2 Loebbecke, Eining and Willingham (1989) use a reasoning equivalent to the “fraud triangle” and call it a “model”. 3 Albrecht et al. (1982, p. 34) and Comer (1977, p. 10-11) present Cressey’s theory. 4 See Ramos (2003), Eilifsen and Messier (2006, p. 87) and Soltani (2007, pp. 538-542). 5 The international auditing standard ISA 240 (IFAC (International Federation of Accountants) 2005), treats ethics in a similar manner as SAS 99. However, the individual morale (and not morals) is mentioned. We carried out a line by line comparison of SAS 99 and ISA 240 with regard to the “examples of risk factors” provided in the appendix of each standard (see Appendix 1). Apart from a few wording differences, we noticed that a few items are present in ISA 240 and absent in SAS 99 (see Table 1). 6 Available at the following address: http://www.citizenworks.org/corp/corp-scandal.php. 7 www.factiva.com. 8 www.sec.gov. 9 Adelphia Communications, Enron, MicroStrategy, Rite Aid, Sunbeam, Waste Management, and Xerox. 10 Money shifted from Parmalat’s coffers to loss-making travel businesses controlled by the founder’s family. 11 Overestimation of oil reserves. 12 Underestimation of the accrual for gift certificates. 13 SEC documents listed in this Appendix were not directly used to fill Table 1 but only to understand the technical and accounting aspects of the corporate fraud.
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Figure 1: Fraud Triangle and Theory of Planned Behavior (TPB) Elements of the “fraud triangle”
Elements of the “Theory of Planned Behavior”
Attitudes (Attitude, character, set of ethical values) Attitude toward fraud Rationalizations
Perceived behavioral control
Intention to engage in fraud
Influence Corresponding element of the TPB
Adapted from Ajzen (1991).
Table 1: Case studies of corporate scandals This table presents a detailed analysis of the motivations of 39 corporate scandals. The components are classified according to the fraud triangle: Incentives/pressures, opportunities, attitudes/rationalizations (this latter component being subdivided into two separate components). The paragraph mentioned after some of the components refer to SAS 99 and ISA 240 (see Appendix 1). If a component is covered by ISA 240 but not by SAS 99, it is underlined. If a component is covered neither by SAS99 nor ISA 240, it is displayed in italics. Incentives/ Pressures
1. Adelphia Communications
To meet Wall Street expectations (§ 2.1).
Family link (§ 2.1).
Ambition for the group: to build an empire. Fixation on growth. Compete with Wal Mart (§ 1.1). Launched mergers => debts => to hide (§ 2.2) Stock options (§ 3.2) Pressure from the financial market which was criticizing the decline in AIG’s reserves (§ 2.1) Important shareholder and share price (§ 3.1) Stock options (§ 3.2)
Relationship with the distributors (§ 1.2).
Growth. To be able to buy the “giant” Time Warner (§ 1.1) Pressure of the financial market: considered advertising revenues as important to measure the performance (§ 2.1.) Share price (§ 3.1) Stock options (§ 3.2)
Use of estimates (§ 1.3)
3. AIG (American International Group)
Complex transactions (§ 1.4).
Attitudes/Rationalizations Attitudes To meet Wall Street expectations (§ 5). To maintain a high leaving standard, greed, “To have the funds to support his lifestyle”. Stock options (§ 4) Greed Company’s success and CEO’s personal success: reputation at stake Managers’ personality (“Mass market retailer of the year 2001”…) Stock options (§ 4) Obsessed by the daily fluctuations in the company’s stock price (§ 4) Company’s success = CEO’s personal success - Reputation – Pride “Imperial chief executive” - The market would lose faith in the company without him. Managers’ personality: tyrannical, nobody dared to oppose him. Stock options (§ 4). Chairman: Narcissist person.
Rationalizations Sees himself as someone very generous and helpful. Money used to help people.
According to him, he acted for the good of the company, and the good of the Company was also his good.
5. Bristol-Myers Squibb
To keep pace with rivals by reporting double-digit profit growth (§ 1.1) To meet internal sales and earnings targets and analysts’ earnings estimates (§ 2.1, 4) Share price (§ 3.1) Stock options, compensation bonus (§ 3.2) To make the merger with HFS possible (§ 1.1). Stock options (§ 3.2).
“Channel stuffing” (sales to wholesalers) (1.2)
Stock options (§ 4) Firm’s culture of “making the numbers”. Managers’ personality (youngest chief executive…) Lack of experience.
Auditor located far away (§ 2.2). Manual accounting systems (§ 4.3).
Personal enrichment: payment of their living expenses (planes, golf). Too high living expenses (§ 9). Personal enrichment with sale of stock options (§ 4). High standard of living (expensive cars). Awards received for the best managed company. “Software titan”. Personal enrichment: boosting the revenues to increase year-end bonuses.
7. Computer associates
Pressure to present strong growth figures (§ 2.1). Stock options (§ 3.2).
Domination of management by a small group (§ 2.1).
8. CMS Energy
Performance-based compensation, yearend bonus (§ 3.2). To be a credible marketer. Possible energy market manipulation. To follow Enron’s example. Growth and creation of a group of companies.
“Round-trip” trades (§ 1.1).
To hide the bad financial state (§ 1). To fund pension obligations. To hide a dispute with General Motors To meet analyst earnings expectations (§ 2.1). Increase of stock price and sale of stocks (§ 3.1). Performance-based salary (stock options, incentives (§ 3.2). Growth (§ 2.1). Stock options (§ 3.2).
Several executives involved (§ 2.1). Auditor’s failure (§ 2.2).
9. Datek Online
11 Dollar General
Highly complex transactions (§§ 1.3, 1.4).
Direct involvement of the CEO in preparing the company’s financial results (§ 2.1).
Donation to and promotion of charitable causes. Built day-care centers for their children in CA offices
High standard of living (personal plane). “Technology wizard”. CEO appears in many rankings. Greed (performancebased salary).
Image of “marketing genius”.
Donation to endow a program on moral leadership at a University.
12 Duke Energy
Performance-based compensation, yearend bonus (§ 3.2)
“Round-trip” trades (§ 1.1).
Salaries based on performance (§ 3.2).
14 El Paso Corporation
Success and profitability. Top-rank of energy traders. Market power. To complete a merger. Ownership and increase of stock price (§ 3.1). Salaries based on performance (§ 3.2). Growth. To enter the burgeoning deregulated energy markets without sacrificing the credit rating.
“Round-trip” trades (§ 1.1). Close relationship between executives. “Round-trip” trades (§ 1.1).
16 Freddie Mac
17 Global crossing
19 Harken Energy
Personal relationship between executives.
To meet analysts’ expectations (reduction of earnings) Appearance of sustained, predictable growth (§ 2.1). Stock options (§ 3.2). Sustainability of the firm (§ 1). To meet securities analysts estimates (§ 2.1). Sale of shares (§ 3.1).
Conflict of interest for the auditor (charity). Corporate culture which encourages fraud to approximate analysts’ forecasts.
Bad state of the economy Sales of shares (§ 3.1). Sales of shares (§ 3.1).
Auditor’s failure. Political link of the managers. Political link of the managers
Swap of network capacity (§ 1.1, 1.2).
Personal enrichment: manipulation to maximize the size of the year-end bonuses and other performancebased compensation To be a leading global energy company.
Personal enrichment (stock price § 4).
Personal enrichment: off-balance sheet partnerships (§ 9). CFO: Image of financial genius, arrogant, self confident. Threat towards analysts. Stock options (§ 4). Personnel ambition (to become the CEO).
Personal enrichment: Consulting and real estate fees. Confusion between company’s assets and his own’s. (§ 9). Greed, ambition: to build an empire (“the Emperor of Greed”. Chairman is bright, aggressive and has a huge ego. “Roman emperor”. Personal enrichment: sale of shares when the business was going bad. Greed. Stock options (§ 4): sale of stock options. Insider trading. Passion for sports (purchase of a football team).
Donation to the city’s art museum, fundraiser for the local Holocaust Museum.
Donation to charities.
Pressure from the market (§ 2.1). Sales of shares (§ 3.1). Salaries based on earnings (§ 3.2).
Lack of experience of certain mid-level executives. Involvement of many executives. Fake entries.
Revenue growth (advertising revenue) (§ 2.1). Contract with AOL Sale of shares (§ 3.1). Growth in revenues. To be able to make an IPO. Collapsing markets of Silicon Valley and the world of high tech. Sales of shares (insider trading) (§ 3.1).
“Round-trip” transactions (§ 1.1). Fraud hidden to auditors.
Competition with Wal-Mart (price war) (§ 1.1). Survival (weight of debts). Performance-based bonuses, stock options (§ 3.2). Internal sales target. External sales target (§ 2.1). Bonus on sales (§ 3.2). Keep their job
Junior executives were demoted or transferred when they refused to make unrealistic forecasts.
To make the Company look successful. Growth in revenues. To ease the IPO of a subsidiary. To boost the firm’s share price.
22 HPL Technologies
23 Im Clone Systems
Greed. Acquisition of planes, house and yacht. CEO “terrorizing his colleagues and employees” (and analysts and journalists). Power and influence (network). Wanted to be the “highest-paid CEO in the world”. Greed (sale of shares). CEO’s power, ambition (the CEO embodied the company).
Donation to charities. Creation of a church.
Admired head of a fastgrowing software company.
The CEO funneled his own money to the company accounts in an attempt to cover fake sales.
Personal enrichment. Standard of living to maintain. To pay debts (secured by the stocks). Insider trading for himself and his family. Protect the wealth of his family and friends. Personal enrichment (personal air travel), loans to themselves. (§ 9).
Total control of the company.
Personal enrichment: bonuses on each sale they achieved. Career: So as to keep their jobs and/or to be promoted, by meeting the internal sales targets. No apparent personal interest.
CEO’s ego. Impressed by wealth. Personal problems (alcohol).
28 Network Associates
29 Peregrine Systems
To become the world’s leading provider of network security products High growth rate targets (§ 2.1). Sale of stock options (§ 3.2). Performance based salary (§ 3.2). Peregrine’s success and viability in the short-run. Insider trading (sale of shares) (§ 3.1). Stock options (§ 3.2).
Unreachable targets. (§ 5). CEO bullying his employees (“suicide [is] sometimes an appropriate response to failure”). Career, image of competence.
Family link (§ 2.1). Outside board member = brother-in-law of the chairman. Auditor’s failure (the auditor even encouraged the fraud). Very little oversight inside the company. Auditor’s failure.
Personal enrichment (stock options) (§ 4). Acquisition of golf membership.
To restore Company’s profitability.
To meet earnings projections (§ 2.1). Double-digit growth (§ 2.1). Ambition: mergers needed Insider trading (sale of shares) (§ 3.1). Bonus based on the stock performance (§ 3.2). Ambition for the company: make the company one of the best energy traders. Enron’s influence (energy market). To do better than his father. => mergers => high debt. Rite Aid as a powerful retail company. Sale of shares (§ 3.1). Salaries based on performance (§ 3.2).
Collusion between several top executives.
Growth in earnings (§ 2.1). Sale of shares (§ 3.1).
32 Reliant Energy
33 Rite Corporation
Round-trip trades (§ 1.1).
Personal enrichment (home, jet, car…). (§ 9). Passion for sports (funding of a basketball team). CEO fascinated his coexecutives (“god”). Passion for burgeoning sports and entertainment empire. Ambition, thirst of power. To build an empire Not to lose face.
Round-trip trades (§ 1.1). New field, new market (no one knew what the size of the market).
Executive’s career and image of competence.
Family link (§ 2.1).
High standard living (helicopter). Real estate transaction with the family. Ambition and competence. Martin Grass was bullying his employees and partners. Worldwide reputation, recognition CEO considered as a miracle worker, a genius by the business world.
Donation to charities.
36 Ullico 37 Waste management
Ambition: image of a growth company. Many (expensive) acquisitions Unauthorized bonuses. Stock options (insider trading) (§ 3.1). Earnings target (§ 2.1). Stock options (§ 3.1). Bonus based on performance (§ 3.2). Company’s performance (§ 2.1). Ever growing revenue and income (§ 2.1). To meet analysts’ forecast (§ 2.1). To maintain the share price Earnings target (§ 2.1). To boost the firm’s share price Increase in compensation (including stock options) (§ 3.1, 3.2).
Personal enrichment (use of loans for luxury apartments, yachts, jewelry, parties) (§ 9). Greed.
Many executives and directors involved. Auditor’s failure.
Personal enrichment with sale of shares. Professional career.
Management hides the truth.
Personal enrichment (shares of the company) (§ 4). Autocratic boss.
Auditor’s failure. Opposition within the board.
Personal enrichment (shares of the company) (§ 4).
Donation to charities. Fund raising for the local college. Scholarships, free telephone service for hurricane victims.
Table 2: Explanation of fraud behaviors not present in the auditing standards Items To maintain a high living standard
sometimes linked to a passion for sports Reputation at stake (company’s success = personal success) Award winner or superlative:
Companies involved (anecdotal evidence) Adelphia Communications, Cendant, Computer Associates, Datek Online, HealthSouth, Im Clone Systems, K-Mart, Phar-Mor, Rite Aid Corporation, Tyco Cendant, Harken Energy, Peregrine Systems, Phar-Mor, Qwest Ahold, AIG, Network Associates, Qwest Ahold, Computer Associates - Youngest chief executive (Bristol-Myers Squibb) - Marketing genius (Dollar General) - Admired head of a fast-growing company, very rich and very young manager (Datek Online) - Highest-paid CEO (HealthSouth) - Worldwide recognition (Sunbeam) - Financial wizard (CFO of WorldCom) - Tyrannical/autocratic (AIG, Enron, HealthSouth, Network Associates, Rite Aid Corporation, WorldCom) - Narcissist (AOL) - Fascination on executives (Phar-Mor) - Personal ambition - career (Freddie Mac, Homestore.com, Reliant Energy, Waste Management) or for the firm (Global Crossing, Qwest) - Alcohol (MicroStrategy) Bristol-Myers Squibb