Well-known Fortune 500 companies with strong growth profiles are more susceptible to “cooking the books” than their smaller, struggling counterparts, according to a study from three US universities. (Schwartz et al, January 2021)

Published in a recent issue of Justice Quarterly, the study examined the characteristics of more than 250 US public firms that were involved in financial securities fraud identified in eight years’ worth of Securities and Exchange Commission (SEC) filings up to 2013. Those characteristics were then compared to the underlying features of a control sample of firms that were not named in SEC fraud filings.

Compiled by researchers from Pennsylvania State University, Miami University and Washington State University (WSU), the data revealed clear fraud-risk trends among corporations that:

  1. were listed in the Fortune 500;
  2. were traded on the New York Stock Exchange, and
  3. had strong growth expectations.

In a statement, WSU sociologist and study lead author Jennifer Schwartz explains: “Prestigious companies, those that are household names, were actually more prone to engage in financial fraud, which was very surprising. We thought it would be companies that were struggling financially, that were nearing bankruptcy, but it was quite the opposite. It was the companies that thought they should be doing better than they were, the ones with strong growth imperatives – those were the firms that were most likely to cheat.” (Washington State University via EurekAlert!, 2 February 2021)

In a more specific part of the study, Schwartz and her team zeroed in on the era around the WorldCom and Enron fraud scandals – encompassing the Sarbanes-Oxley Act of 2002 – with the aim of identifying conditions at publicly traded firms that provided a greater risk for fraud. The team found that companies with Fortune 500 status were represented almost four times as often among fraudulent firms than in the nonfraudulent control group.

In addition, firms that traded on the New York Stock Exchange were over-represented among fraudulent versus nonfraudulent firms by almost two to one: a higher rate than those that traded on other exchanges such as NASDAQ or OTC.

Across the study, the team also found that fraud occurred more often in firms where the CEO served as chair of the board – a connection, Schwartz added, that she and her team are now investigating further: "We need to look more at corporate leadership arrangements, and the responsibility of individuals in creating the culture of the company itself.”

What do these findings tell us about governance at large corporates? Is it inevitable that a significant risk profile will always accompany a strong growth profile?

The Institute of Leadership & Management’s head of finance and corporate services Melanie Robinson says: “In organisations that have grown rapidly and retain their original founders, it’s sometimes the case that the CEO will also serve as chair of the board. This can create a conflict of interest, as it’s the role of the board to monitor corporate governance. Good financial governance by a board of directors or trustees requires that an organisation collects, calculates and presents financial data accurately – but it can be difficult for one person, as Chair and CEO, to monitor this themselves.”

She notes: “The Sabanes-Oxley Act (US SOX) accounts for this situation, requiring that there is an independent audit committee which has no manager of the business as a member. A recent meeting of The Audit Committee Chairs’ Institute Forum (ACCIF) suggested a framework for a ‘UK SOX’. However, this is largely covered by The UK Corporate Governance Code, which requires​ every board to form a view on its organisation’s internal controls.”

Robinson points out: “To achieve strong growth profiles, many CEOs have to take strategic risks. Yet it’s this attitude to risk that can lead to improper financial activity. So, having a strong leadership team that leads ethically is essential. Ethical leaders understand that they must put the values of the organisation before anything else.”

She adds: “Sometimes, it can be difficult to do the right thing – especially when under pressure to meet budgets or targets. Yet it is the responsibility of the leadership team to ensure controls are in place to do exactly that.”

For further thoughts on the themes raised in this blog, check out the Institute’s resources on ethics.


Source refs:

Schwartz et al, January 2021

Washington State University via EurekAlert!, 2 February 2021