Dire consequences for companies engaging in financial fraud
Accounting fraud usually starts at the top of the corporate ladder, but its effects filter all the…
Georgia (Jul 13, 2010) —
Accounting fraud usually starts at the top of the corporate ladder, but its effects
filter all the way back down.
Dana Hermanson, Dinos Eminent Scholar of Private Enterprise and accounting professor
at Kennesaw State University’s Coles College of Business, said a recent 10-year study
from the Treadway Commission found that in 90 percent of the 347 cases of alleged
fraudulent reporting it identified in public companies from 1998-2007, CEOs and CFOs
were implicated in the U.S. SEcurities and Exchange Commission investigations.
“But that’s only the beginning of the consequences," said Hermanson, co-author of
the study. "The repercussions go on to affect employees, stockholders and board members.”
Hermanson compared companies investigated for fraud with those that were not.
“We found that 25 percent of the companies under investigation for accounting fraud
had abnormal stock declines (an average of 17 percent) within two days of the fraud
announcement,” he said. “Twenty-eight percent of the alleged fraud companies went
bankrupt or had to liquidate assets within two years, and 47 percent of these companies
were de-listed from a stock exchange, which impacted both the company’s reputation
and access to capital.”
The Treadway Commission has published fraudulent accounting data studies for three
decades in an effort to better understand and to help reduce corporate accounting
fraud.
The latest study showed a spike in money involved in the cases.
“There were 347 cases in 1998-2007 versus 294 cases in 1987-1997, but the dollar
amount soared to nearly $400 million per case. By comparison, the mean was $25 million
per case in the decade before,” Hermanson said. The latest decade included the dot.com
bust of 2001, and the high-profile fraud cases of Enron, Tyco International and WorldCom.
“There is fraud against the company for personal gain, such as embezzlement," Hermanson
said. "Then there is fraud on behalf of the company. Someone adjusts the accounting
to make the company performance look better. We studied the second kind.”
Sometimes fraudulent accounting begins with good intentions, but the results generally
backfire.
“Fraudulent reporting often starts small, and can start with someone who has a good
motive,” said Dennis Beresford, Ernst & Young Executive Professor of Accounting at
the University of Georgia’s Terry College of Business. “Maybe the person sees the
company having temporary problems and wants to help it through a bad patch, so he
doesn’t record a loss, or shifts future sales into the present quarter. He may think
he’s avoiding the bank calling in a loan or having to lay off employees. When things
don’t get better in the next quarter, he has to keep making up numbers and eventually
gets caught. Then the fallout hits everyone.”
Pressure to make earnings projections can lead to fraudulent behavior, as can the
payoffs of higher stock prices and options and executives getting to hit bonus pay
targets.
“Missing a projected earnings report by one penny can cause stock prices to drop
$10 a share,” Beresford said. “Companies try hard to be successful, but they need
to do it by legitimate means.”
Beresford said he is encouraged that there haven’t been more "gargantuan" frauds
like Enron and WorldCom lately. He attributes that, in part, to the Sarbanes-Oxley
Act of 2002.
“After Enron, there were congressional hearings but no move to legislation. When
WorldCom hit in June of 2002, it was the straw that broke the camel’s back. Within
a month, Congress had passed Sarbanes-Oxley to set new financial standards and regulations,”
Beresford said. “Now we’re seeing people pay more attention to company records and
auditors doing their jobs better. We have better tools all the time to detect fraud
and whistle-blower provisions.”
The main lessons to be learned from corporate fraud are that it hurts everyone and
that people in the trenches need to speak up, Beresford said. “With WorldCom, there
were managers who could see something wasn’t right, but they figured the CFO knew
more than they did and didn’t say anything.”
Paying attention to company culture is one of the best ways to prevent fraud, Hermanson
said. “A ‘make the numbers or you're out the door’ approach to sales, huge rewards
for making targets, an attitude of never missing projections, or management seeing
Sarbanes-Oxley as a waste of time, could be signs of an unhealthy culture,” he said.
“Always be skeptical. If someone asks you to do something that doesn’t make sense,
question it.”
“Standing up and challenging bad behavior takes courage,” Beresford said, “but it
has to be done.”
Publication
Link To Article
http://www.ajc.com/lifestyle/dire-consequences-for-companies-568972.html
A leader in innovative teaching and learning, Kennesaw State University offers more than 150 undergraduate, graduate and doctoral degrees to its approximately 41,000 students. With 11 colleges on two metro Atlanta campuses, Kennesaw State is a member of the University System of Georgia and the third-largest university in the state. The university’s vibrant campus culture, diverse population, strong global ties and entrepreneurial spirit draw students from throughout the region and from 92 countries across the globe. Kennesaw State is a Carnegie-designated doctoral research institution (R2), placing it among an elite group of only 6 percent of U.S. colleges and universities with an R1 or R2 status, and one of the 50 largest public institutions in the country. For more information, visit kennesaw.edu.
