Study: Financial Fraud Isn't Really the CFO's Fault
Blame Enron CEO Ken Lay, not CFO Andrew Fastow, for the fact that the company books were a mess. Similarly, Bernie Ebbers should be penalized, not CFO Scott Sullivan, for financial shenanigans at WorldCom.
Why? Research from the University of Washington's Foster School of Business and the University of Pittsburgh shows that CFOs who committed fraud often weren't motivated by personal gain. Instead, they cooked the books to appease their boss.
The research found that the CEOs not only have the leverage to get others to commit fraud, but substantial incentives to do so. "Our findings are consistent with the explanation that CFOs are involved in material accounting manipulations because they succumb to pressure from CEOs, rather than because they seek immediate personal benefit from their equity incentives," says co-author and Foster professor Terry Shevlin.
CEOs Most Like to Profit
While it's tough to determine an exact motivation for fraud, the researchers gave it a good try: They looked at the equity incentives of top management in companies involved in 676 fraud cases handled by the U.S. Securities and Exchange Commission between 1982 and 2005. They then compared those incentives to those of executives at companies where no fraud occurred. There were no differences in CFO incentives at firms where fraud took place compared to those where no fraud was found. Incentives for CEOs were another story: CEOs at firms that committed fraud had higher equity incentives and more power than those at the law-abiding firms.
Another interesting fact: At firms where fraud was eventually discovered, CFO turnover was higher in the three years preceding the fraud than it was at law-abiding firms, suggesting that some of these CFOs were either forced out or quit when pressured to cook the books. The researchers also found that in the final analysis, it was more often the CEO-not the CFO-who actually altered the company's financials in a fraudulent way.
The Solution: Install A Buffer
Weill Ge, one of the study's co-authors and a Foster professor, says both equity incentives and corporate governance need to be fixed to prevent accounting fraud. One solution would be to try to provide a buffer between the CFO and his or her boss, the CEO. Ge says that, while it's difficult to implement, at some companies, the CFO reports directly to the board of directors' audit committee.
How independent are the finance folks at your company? And do you think the CEO is powerful enough to push them into wrongdoing?
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