Fraudulent financial reporting: A deception based on predisposition, motive and opportunity

This dissertation concerns fraudulent financial reporting, the deliberate attempt by management to convince the readers of the financial statements that the firm's financial reports have been prepared in accordance with Generally Accepted Accounting Principles when they have not. The focus is on those aspects of the firms organizational culture that predispose it to consider an illegal action to be a legitimate business behavior. Using Institutional Theory, a model is developed that views this accounting phenomenon as a function of predisposition, motive and opportunity.; A sample of 113 firms that issued fraudulent financial statements in the five-year period from 1992 to 1996 are matched with an equal number of firms that have not been found guilty of fraudulent reporting. The results support the theory that certain aspects of the firm's culture predisposes it to consider fraudulent financial reporting to be an acceptable accounting policy. Signs of such a culture are the existence of related party transactions, the absence of a professional accountant and the continuing influence of the firm's founder. The motivation for fraudulent financial reporting is positively related to the need to raise additional capital and ownership pressures from management and negatively related to the presence of long-term institutional investors. The opportunity to actually release these illegal statements increases when there is a large percentage of insiders on the firm's Board of Directors and the firm does not have a Big-Six auditor. Overall, the results support the theory that if the firm is predisposed to act illegally then it is more likely to issue fraudulent financial statements given high levels of motive and opportunity. These findings are of use to auditors, investors and regulators.