The Influence of Management Bonding on Firms’ Financial Reporting Risk

Abstract

I investigate how top management cohesiveness/bonding affects firms’ financial reporting risk. I operationalize team cohesiveness/bonding by measuring the social connections among the top executives of firms through four types of social networks: educational background, employment history, off-the-job organization activities, and board positions. Using a sample of firms identified in the Accounting and Auditing Enforcement Releases (AAERs), I find that top management who are more cohesive and bonded through social connections are more likely to commit accounting misconduct. The cohesiveness/bonding among top management teams is associated with more years of financial misstatements and lower probability of misstatement detection. These results are consistent with a well-documented “groupthink” phenomenon in social psychology that is associated with dysfunctional decision-making processes. The results highlight the importance of considering social bonding status as a risk factor in investigating and detecting financial fraud.