Fear’s Impact on Accounting Fraud is Actually Kind of Spooky

by FEI Daily Staff

Greed may be “good” when it comes to the movie version of the corporate swindle, but it’s actually fear that may be driving a majority of accounting fraud in the real world.

Fear and embarrassment -- rather than lining executive pockets-- may be the primary motivating factor for private and public company executives succumbing to financial statement fraud, according to recently published research.

“This loss of reputation and status for the company executive creates a primary motivator that is the fear of failure,” says the paper released at a gathering on management scholarship. “Although there can be gain to the company, the fraud, itself, is not gaining financial position for management as much as it is preventing the loss of financial position. This is motivation for executives that revolve around potential damages to their ego when their failed vision for the company is known.”

The research cites recent academic work on mice.

Not actually lab rats, but a theory of fraud motivation (money, ideology, coercion and ego) M.I.C.E., which argues that motivators other than pure financial gain are involved in the commission of some fraudulent activity. “Fear of failure would fall under the auspices of Ego according to this theoretical framework,” the paper states.

The paper’s author, Frank Lombardo, cites historic fraud cases from the British East India Company of the 17th century to Enron as cases where fear of failure drove fraudulent financial statements.

For example, in the case of Enron, the paper argues that executives set up Special Purpose Entities (SPEs) to move debt off the balance sheet in a way that covered up losses because of the fear of possible financial failure (rather than gaining economic advantage). Once the losses were reversed and “presumably corrected by management’s leadership,” the fear of embarrassment would have been avoided. The paper also cites the early 1990’s fraud case of discount pharmacy Phar Mor, where the CFO acquiesced to the fraud even though he received no financial benefit outside of his existing compensation.

“Fear is a powerful motivator and it is usually not considered when frauds have occurred nor is it considered in regulatory planning designed to deter fraud such as the Sarbanes-Oxley act of 2002,” the author concludes. “The positions of this paper could if proven to be accurate provide insight for fraud examiners, regulators and even management in determining how to prevent, detect and stop fraud from occurring.”