Financial Misconduct Research Articles

Home State CEOs and Financial Misconduct Litigation

Home State CEOs and Financial Misconduct Litigation

Hedge Fund Ownership and Corporate Financial Misconduct

Hedge Fund Ownership and Corporate Financial Misconduct

Does national culture influence malfeasance in banks around the world?

We examine the extent to which national culture influences the severity of financial misconduct by banks globally. Using cultural background information of the country where a bank is headquartered, we detail strong evidence that individual over-confidence increases bank misconduct while uncertainty avoidance reduces it. The findings hold with alternative national culture and loss measures, using instrumental variable two-stage least squares, excluding Anglo-Saxon countries, for US sanctions only and, for individual over-confidence, across states within the US. Regulatory capital stringency and supervisory independence can help to counter the influence of individual over-confidence on such losses. The findings outlined are relevant to regulators, policymakers, and banking practitioners seeking to mitigate malfeasance in financial institutions.

Green innovation in oil and gas exploration and production for meeting the sustainability goals

This study assesses how green innovation influences sustainability within the Chinese oil and gas industry. The analysis employs the CS-ARDL (Cross-sectionally Augmented Autoregressive Distributed Lag) technique, focusing on a case study involving 100 publicly listed companies from 2010 to 2020. Sustainability is approximated by energy efficiency, unveiling substantial correlations between technology investment, ESG (Environmental, Social, and Governance) funding, stock valuation, tax disbursements, financial misconduct, and energy efficiency. Augmented investments in technology and ESG initiatives exhibit favorable impacts on energy efficiency both in the short and long run, underscoring the importance of strategic investments in progressive technologies and sustainable ventures. Conversely, higher tax disbursements and instances of financial misconduct detrimentally affect energy efficiency, emphasizing the necessity to address these issues to bolster sustainability. Tangible policy suggestions encompass the advocacy for green finance, the implementation of an effective emission taxation framework, provision of incentives for eco-friendly research, and the establishment of a local network for green innovation among oil and gas enterprises, aiming to nurture sustainable practices.

Information Complementarities and the Dynamics of Transparency Shock Spillovers

ABSTRACTWe show that information complementarities play an important role in the spillover of transparency shocks. We exploit the revelation of financial misconduct by S&P 500 firms, and in a “Stacked Difference‐in‐Differences” design, find that the implied cost of capital increases for “close” industry peers of the fraudulent firms relative to “distant” industry peers. The spillover effect is particularly strong when the close peers and the fraudulent firm share common analyst coverage and common institutional ownership, which have been shown to be powerful proxies for fundamental linkages and information complementarities. We provide evidence that increase in the cost of capital of peer firms is due, at least in part, to “beta shocks.” Disclosure by close peers—especially those with co‐coverage and co‐ownership links—also increases following fraud revelation. Although disclosure remains high in the following years, the cost of equity starts to decrease.

Local happiness and corporate financial misconduct: Does happiness reduce organizational opportunistic behavior?

This study explores the impact of local happiness on corporate financial misconduct. Using large-scale survey data to construct the measurement of the local happiness level, we find that firms headquartered in happier regions are less likely to engage in financial misconduct. Our mechanism analysis indicates that local happiness promotes the building of regional social capital and the cost of misconduct is higher in regions with higher happiness levels, which explains the mitigating effect of local happiness on corporate misconduct. Moreover, the effect of local happiness is more salient when firms are in regions with a lower level of marketization and less financial supervision expenditures and firms with weaker corporate governance mechanisms and risk tolerance. Our results highlight that happiness, a measure of subjective well-being, can serve as a substitute for formal institutions to alleviate organizational misconduct, especially when formal institutions are weak.

Investor reactions to apologies for financial misconduct

We conduct three experiments to examine the implications of corporate apologies on investors' reactions to allegations of financial misconduct. In Experiment 1, we manipulate whether the firm apologizes or denies the misconduct. Additionally, we manipulate how the firm apologizes for (denies) the misconduct by comparing “basic” response strategies (i.e., responses containing nothing more than a simple apology or denial) with “full” response strategies (i.e., responses containing additional elements, such as explicitly naming the misconduct). We find that investors are less willing to invest when the firm apologizes than denies it. Using mediation analysis, we find that when investors observe an apology, they attribute more responsibility to the management for the events, leading to a lower perception of credibility and a higher perception of litigation risk, ultimately affecting their investment judgment. Our results do not provide evidence that more extensive responses affect investors differently than more basic apologies or denials. In Experiment 2, we investigate self-disclosure as a potential strategy for firms to mute investors' negative reactions to apologies. Our results replicate the findings of Experiment 1. However, we do not find evidence that management can attenuate the adverse effects of apologizing for misconduct by self-disclosing the misconduct. In Experiment 3, we separate whether the apology includes an acceptance of responsibility or not and whether there is subsequent evidence of guilt or evidence of innocence. Surprisingly, investors do not react more favorably to apologies (with or without acceptance of responsibility) than denials, even when evidence substantiates the allegations. Overall, our study demonstrates that it is difficult for managers to attenuate the negative effects of financial misconduct on investors’ perceptions with apologies.

The Effectiveness of Internal Controls in Preventing Fraud and Financial Misconduct

Objective: The objective of this study is to examine the role of internal control in mitigating fraud and professional misconduct among small and medium-sized businesses (SMEs) within the Enugu metropolis.
 
 Method: To achieve this objective, a mixed-methods approach was employed. Qualitative interviews were conducted with SME owners and managers, and quantitative data were collected for analysis. A sample of SMEs was selected from the Enugu metropolis, and their internal control mechanisms, maintenance practices, and effectiveness in reducing fraud and professional misconduct were assessed.
 
 Result: The study's findings reveal several key insights. Firstly, SMEs in the Enugu metropolis actively create and implement internal control measures tailored to their operational needs. Secondly, SMEs that consistently maintain and update their internal controls experience a significant decrease in instances of fraud and professional misconduct. Finally, there is a clear correlation between well-implemented internal controls and reduced levels of fraud and professional misconduct within SMEs.
 
 Conclusion: In conclusion, the study highlights the crucial role of internal control in addressing the challenge of fraud and professional misconduct, especially within SMEs. SME owners and managers should assess their existing internal control mechanisms to ensure they are well-suited to their business operations. Regular review and adaptation of internal controls are necessary to sustain their effectiveness in preventing and detecting fraudulent activities. Proper maintenance of financial records and regular statement preparation contribute significantly to the success of internal control systems.

Uncovering Financial Fraud: The Vital Role of Forensic Accounting and Auditing in Modern Business Practice

Abstract This article explores the critical roles of forensic accounting and auditing in modern business, focusing on uncovering financial irregularities and promoting transparency. Through a meticulous literature review and analysis, the study emphasizes the significance of these practices. The purpose is to underscore their importance, methodologies, and implications. Methodologically, the article employs a comprehensive literature review and meticulous analysis of real-world applications. It investigates cases of corporate fraud, financial statement analysis, and dispute resolution. Ethical and legal considerations are highlighted, emphasizing the adherence to professional codes and standards. The study reveals that forensic practices are pivotal in detecting financial misconduct, upholding financial transparency, and ensuring accountability. Technological advances, such as data analytics and AI, enhance efficiency and accuracy. The research establishes the need for continuous development and professional education to tackle the evolving financial challenges. In summary, this article highlights the central roles of forensic accounting and auditing in modern business, their methodologies, and ethical considerations. The study underscores their importance in detecting financial fraud, promoting transparency, and fostering trust.

Financial misconduct and corporate innovation: evidence from China

PurposeThis study aims to examine the real effects of financial misconduct on corporate innovation.Design/methodology/approachThe authors use a sample of Chinese A-share listed firms from 2006 to 2017. This study uses several empirical strategies to deal with endogeneity concerns, including Heckman’s two-stage correction approach, propensity score matching and instrumental variables.FindingsThe authors’ findings consistently show that financial misconduct impedes corporate innovation. Furthermore, the authors’ analysis demonstrates that the negative impact of financial misconduct is more pronounced in nonstate enterprises. The authors also show that financial misconduct discourages innovation through information, short-termism and financing channels.Practical implicationsThis paper is of particular interest to policymakers, as firm behavior is heavily regulated and altered by securities laws and regulations over time. The authors recommend firms to observe financial regulatory laws to promote capital market integrity and enhance shareholder value through innovation projects. The authors also recommend that regulators provide incentives that encourage corporate transparency and use new technologies to detect financial misconduct quickly.Originality/valueFew studies in literature investigate the real consequences of financial misconduct on firm investments. Hence, this paper fills this gap by analyzing the implications of financial misconduct on corporate innovation. This study is one of the first to provide new insights into the adverse effects of financial misconduct on firm-level innovation, supported by empirical evidence.

NUMBERS DON’T LIE: DECODING FINANCIAL ERROR AND FRAUD THROUGH BENFORD’S LAW

This research investigates Benford’s Law as a statistical instrument to detect financial fraud and errors. Benford's Law, also known as the First-Digit Law, states that lesser digits, specifically '1', frequently appear as the leading digit in numerous numerical datasets, and deviations from this distribution may indicate potential financial irregularities. This research examines literature demonstrating the application and efficacy of Benford’s Law in identifying numerical inconsistencies indicative of financial misconduct. This research investigates the use of Benford’s Law as a tool of detecting error and fraudulent activities within the sales data of two branches during 2022. A comprehensive dataset of 3098 records from Bandung and 539 records from Surabaya was collected after excluding certain data points that exhibited abnormalities. The application of Benford's statistical test discovered a discrepancy between the Benford probability and the observed probability, suggesting the presence of possible errors and frauds. The audit findings unveiled anomalies in pricing and instances of fraudulent activities in both locations, primarily due to pricing discrepancies and incorrect price inputs from sales orders. Furthermore, instances of fraud involved the manipulation of set prices for personal gain by salesmen. The results affirmed the hypothesis that a larger deviation between Benford’s probability and the observed probability corresponded with a higher incidence of error and fraud. However, it observes that Benford’s Law is not a stand-alone solution for detecting fraud, as not all financial datasets conform to it and deviations from the law only indicate the possibility of fraud, not confirm it. Therefore, the research suggests using Benford’s Law in conjunction with other data analysis and auditing techniques to conduct a comprehensive investigation. The conclusion of research emphasizes the significance of Benford’s Law in the field of forensic accounting and the need for multidimensional strategies for effective error and fraud detection.

Financial Misconduct in Family Firms: The Role of Organizational Identification

Financial Misconduct in Family Firms: The Role of Organizational Identification

The Strain-based Model of Overperformance and Corporate Financial Misconduct: The Role of Ownership

The Strain-based Model of Overperformance and Corporate Financial Misconduct: The Role of Ownership

Informed trading prior to financial misconduct: Evidence from option markets

This paper shows an abnormal level of option trading activities in the ten days before the revelation of financial misconduct in a sample of the SEC and/or DOJ enforcement actions. These abnormal option trading volumes are negatively associated with the subsequent stock returns to the announcements, and are positively linked to firm penalty, the number of violations, prison sentences, fraud charge, top executives number, potential firm deception toward auditors, impeded investigation, and violation period. Finally, abnormal option trading is related to the time to discovery and the likelihood of discovery. These results suggest that option traders detect firms engaged in financial misconducts.

The spillover effects of financial misconduct on director‐interlocked firms: Evidence from auditor scrutiny

AbstractThis paper examines the impact of firm financial misconduct on its director‐interlocked firms from the perspective of auditors. We argue that when a firm engages in financial misconduct, auditors tend to perceive its director‐interlocked firms as having higher audit risks. This is because accounting policies, procedures and corporate governance can propagate via common directors. Using a sample of listed US firms from 1999 to 2018, we find that auditors charge higher fees for firms whose director‐interlocked firms engage in financial misconduct. Further analyses show that this spillover effect is stronger when focal firms are riskier (when they are financially distressed or have worse earnings quality) or they have weaker alternative monitoring mechanisms (as evidenced by lower institutional shareholding). The effect is also more prominent when the tainted directors hold important positions or the financial misconduct is more severe. We also find that the higher auditor fees arise from not only risk premium but also greater audit effort. Our results are still valid after conducting a series of robustness tests.

Money in the age of bits and bytes: Technology in reshaping finance

In contemporary times, there has been a growing convergence between the finance and technology sectors. The emergence of FinTech has revolutionized the delivery of financial services and created new opportunities for innovation in the financial sector. The use of artificial intelligence, blockchain, and mobile banking are examples of how technology is reshaping the financial industry. This case explores the emergence of the Indian banking sector’s adoption of technology, starting with computerization in the late 1980’s and its growth through to the present day. Financial services have benefited from technology in the form of streamlined processes, lower costs, happier customers, and easier access to relevant data. In addition, by using technology, risk can be evaluated, superior investments can be made, and customer habits may be comprehended. Conversely, technology presents a set of difficulties such as cybersecurity risks, financial misconduct, prejudiced algorithms, and the marginalization of specific demographics from digital financial amenities. This case brings out the perspective that the future of financial services is expected to be shaped in large part by the effects of technological progress.

ESG Capitalism from a Law and Religion Perspective

In an age of fear, insecurity, and multiple and overlapping crises, the fortunes of ESG—the idea that companies should include environmental, social, and governance standards of good performance—are now steadily growing. This is all the truer in the West, where corporate financial misconduct and, more worryingly, corporate political activities impacting democratic processes, have become a matter of evident concern. Business scholars and policymakers are, however, still uncertain about which corporate activities merit an ESG label, with pressure groups pushing for their own ESG definitions and standards according to their agendas and beliefs. Against this background, this paper contributes to this Special Issues’ guiding question of how religions can act as agents of civic mobilisation by critically examining their role in addressing sustainability topics due to religious concerns from a legal perspective. This current paper hopes to create a preliminary intellectual bridge between two apparently unrelated fields of research (law and religion; corporate governance) that could help scholars in both areas to develop expertise and sophistication in applying their respective specialities to an otherwise unfamiliar area.

Enforcement Waves and Spillovers

We document that regulatory enforcement actions for financial misrepresentation cluster in industry-specific waves and that wave-related enforcement has information spillovers on industry peer firms. Waves and spillovers have significant effects on share prices. Early-wave target firms have the largest short-run losses in share values and the largest information spillovers on industry peer firms. Late-wave targets’ short-run losses are smaller, but not because they involve less costly instances of misconduct. Rather, late-wave targets are subject to more information spillovers from earlier in the wave. These results indicate that prices incorporate changes in the likelihood that a firm will face wave-related enforcement action for financial misconduct. Short-window share-price losses understate the total share-price impact, particularly for firms whose financial misrepresentation is revealed late in an enforcement wave. This paper was accepted by David Simchi-Levi, finance. Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2023.4711 .

The Role and Impact of Forensic Investigations Unit in the Fight Against Fraud, Corruption, Irregularities, Financial Misconduct and Maladministration in the Public Sector of South Africa

This article examines the role and impact of the Forensic Investigations Unit in the fight against fraud, corruption, irregularities, financial misconduct and maladministration in the public sector of South Africa. Section 85(b) of the Public Finance Management Act, 1 of 1999 (PFMA) requires the Minister of Finance to craft regulations stipulating matters relating to the investigations of allegations of financial misconduct. The study adopted a qualitative research approach. Eight (8) participants from the Forensic Investigations Units of various state departments/ institutions were interviewed using open-ended questions. The study followed a purposive sampling guide as a participant were purposively selected. The study found that the role of the Forensic Investigations Unit in the public sector is to investigate the allegations of common law offences such as fraud, corruption, maladministration and financial irregularities. This Unit's impact is to reduce fraud and corruption incidents within the public sector and promote ethical public service through its recommendations. This study recommends amendments to the Public Service Act 1994 (PSA) and Part Three of the Public Service Regulations 2016 (PSR). The amendment is to fulfil the role of the Forensic Investigations Unit as part of a multi-anti-corruption agency in government departments/agencies. It is hoped to resolve reported allegations of fraud, corruption, irregularities and maladministration in the South African public sector quickly and effectively.

Observable placement of phasor measurement units for defense against data integrity attacks in real time power markets

Integrity data (DI) attacks are considered malicious cyber threats to the economic performance of power markets in current power systems. A cyber attacker could mislead the system operator by implementing a DI attack, through the deviation of measured information, and causes non-optimal power distribution and erroneous participation in the electricity market (EM). This paper proposes a placement scheme of phasor measurement units (PMUs) to defend against these attacks, so that network observability is guaranteed; the possibility of detecting DI attacks by the operator is increased; and the effect of electricity price fluctuations caused by these attacks is prevented. For this purpose, we introduce two possible indices to determine the degree of attack detectability and the magnitude of system congestion variation. Accordingly, the two-objective placement model of PMUs is upgraded, in which the minimum number of PMUs and their placement must be specified to improve the proposed indices so as to minimize the possibility of financial misconduct taking place in the real time market. Using IEEE standard systems, the effectiveness of this PMU placement-based defense scheme has been confirmed.