400 words

Theoretical Frameworks

carefully read the article. Each covers a different theoretical topic. Consider how 1 of these theoretical topics could have applicability for your own research problem or issue.

My research is risk management in the bank

Focus your discussion on the following:

· Include a description of the theoretical topic, along with associated definitions relevant to the theoretical/conceptual area.

· Explain how you could use these theoretical/conceptual ideas or theories to narrow the focus of your selected research problem area.

The Role of Power in Financial Statement Fraud Schemes

Chad Albrecht • Daniel Holland • Ricardo Malagueño •

Simon Dolan • Shay Tzafrir

Received: 24 June 2011 / Accepted: 12 December 2013 / Published online: 7 January 2014

� Springer Science+Business Media Dordrecht 2014

Abstract In this paper, we investigate a large-scale

financial statement fraud to better understand the process

by which individuals are recruited to participate in financial

statement fraud schemes. The case reveals that perpetrators

often use power to recruit others to participate in fraudulent

acts. To illustrate how power is used, we propose a model,

based upon the classical French and Raven taxonomy of

power, that explains how one individual influences another

individual to participate in financial statement fraud. We

also provide propositions for future research.

Keywords Financial statement fraud � Organizational corruption � Recruitment � Collusion � Power and influence


In recent years, fraud and other forms of unethical behavior

in organizations have received significant attention in the

business ethics literature (Uddin and Gillet 2002; Elias

2002; Rockness and Rockness 2005; Robison and Santore

2011), investment circles (Pujas 2003; Albrecht et al. 2011),

and regulator communities (Farber 2005; Ferrell and Ferrell

2011). Scandals at Enron, WorldCom, Xerox, Quest, Tyco,

HealthSouth, and other companies created a loss of confi-

dence in the integrity of the American business (Carson

2003) and even caused the accounting profession in the

United States to reevaluate and reestablish basic accounting

procedures (Apostolon and Crumbley 2005). In response to

the Enron scandal, the American Institute of Certified

Public Accountants issued the following statement:

Our profession enjoys a sacred public trust and for more

than one hundred years has served the public interest.

Yet, in a short period of time, the stain from Enron’s

collapse has eroded our most important asset: Public

Confidence. (Castellano and Melancon 2002, p. 1)

Financial scandals are not limited to the United States

alone. Organizations in Europe, Asia and other parts of the

world have been involved in similar situations. Notable

cases include Parmalat (Italy), Harris Scarfe and HIH

(Australia), SK Global (Korea), YGX (China), Livedoor

Co. (Japan), Royal Ahold (Netherlands), Vivendi (France),

and Satyam (India). The business community worldwide

has experienced a syndrome of ethical breakdowns,

including extremely costly financial statement frauds.

An organization’s financial statements are the end

product of the accounting cycle and provide a representa-

tion of a company’s financial position and periodic per-

formance. The accounting cycle includes the procedures

C. Albrecht (&) � D. Holland Huntsman School of Business, Utah State University, Logan,


e-mail: chad.albrecht@usu.edu

D. Holland

e-mail: daniel.holland@usu.edu

R. Malagueño

University of Essex, Colchester, UK

e-mail: rmalag@essex.ac.uk

S. Dolan

ESADE Business School, Universidad Ramon Llull,

Barcelona, Spain

e-mail: simon.dolan@esade.edu

S. Tzafrir

Faculty of Management, University of Haifa, Haifa, Israel

e-mail: stzafrir@research.haifa.ac.il


J Bus Ethics (2015) 131:803–813

DOI 10.1007/s10551-013-2019-1http://crossmark.crossref.org/dialog/?doi=10.1007/s10551-013-2019-1&domain=pdfhttp://crossmark.crossref.org/dialog/?doi=10.1007/s10551-013-2019-1&domain=pdf

for analyzing, recording, classifying, summarizing, and

reporting the transactions of a business or organization.

Financial statements are a legitimate part of good man-

agement and provide important information for stake-

holders (Power 2003; Epstein et al. 2010). Financial

statement fraud has been defined as an intentional mis-

representation of an organization’s financial statements

(National Commission on Fraudulent Financial Reporting


Financial statement fraud is primarily a top-down form

of fraud that negatively impacts individuals, organizations,

and society. As a result, it is important to understand why

individuals become engaged in financial statement fraud.

While research has suggested how a single individual

becomes engaged in financial statement fraud (Ramos

2003; Wolfe and Hermanson 2004; LaSalle 2007; Nocera

2008), we still do not understand how groups of individuals

become involved. In this paper, we seek to contribute to the

literature by considering how top management recruits

others to participate financial statement fraud.

Literature Review

Various efforts have been made to curb fraud and other

forms of organizational corruption. For example, legisla-

tion such as the Sarbanes–Oxley Act that was passed in

2002 by the United States Congress was created to mini-

mize financial statement fraud. One of the top priorities of

the Public Company Accounting Oversight Board

(PCAOB) has been to minimize the occurrence of fraud

(Hogan et al. 2008). Other organizations, such as the

Association of Certified Fraud Examiners (ACFE) were

created to educate and train professionals to detect and

prevent fraud.

Research that addresses the behavioral aspects of fraud

has generally focused on various theories of management,

especially that of agency theory (Albrecht et al. 2004).

Agency theory assumes a principle-agent relationship

between shareholders and management (Jensen and Mec-

kling 1976). Under agency theory, top managers act as

‘‘agents,’’ whose personal interest do not naturally align

with company and shareholder interest. Agency theory

assumes that management is typically motivated by self-

interest and self-preservation. As such, executives will

commit fraud because it is in their best, personal, short-

term interest (Davis et al. 1997). In order to limit financial

statement fraud and other forms of organizational corrup-

tion, researchers suggest that organizations provide

employee incentives that better align management behavior

with shareholder goals. Furthermore, shareholders seek to

institute controls that will limit the possibility that execu-

tives will maximize their own utility at the expense of

shareholders (Donaldson and Davis 1991).

In the last few years, there has been an increased volume

of research by scholars within the management community

that addresses fraud and other forms of corruption from a

humanistic approach. Recent research in this area has

addressed circumstances that influence self-identity in

relation to organizational ethics (Weaver 2006), collective

corruption in the corporate world (Brief et al. 2000), nor-

malization and socialization, including the acceptance and

perpetuation of corruption in organizations (Anand et al.

2004), the impact of rules on ethical behavior (Tenbrunsel

and Messick 2004), the mechanisms for disengaging moral

control to safeguard social systems that uphold good

behavior (Bandura 1999), and moral stages (Kohlberg

1984). In addition to this work, there has been substantial

research into the various aspects of whistle blowing.

(Dozier and Miceli 1985; Near and Miceli 1986).

Classical Fraud Theory and the Initiation of Financial

Statement Fraud

Classical fraud theory has long explained the reasons that a

single individual becomes involved in financial statement

(or any type of) fraud. This theory suggests that there are

three primary perceptions or cognitions that influence

individuals’ choices to engage in fraud. These three factors

are often represented as a triangle and consist of perceived

pressure, perceived opportunity, and rationalization (Suth-

erland 1949; Cressey 1953; Albrecht et al. 1981).

The first element in the fraud triangle is that of pressure

or motivation. Motivation refers to the forces within or

external to a person that affect his or her direction, inten-

sity, and persistence of behavior (Pinder 1998). At a very

basic level, motivation starts with the desire to fulfill fun-

damental needs, such as food, shelter, recognition, financial

means, etc. These desires lead to behaviors that the indi-

vidual believes will result in the fulfillment of such needs.

In financial statement fraud, the motivation or pressure

experienced by the initial perpetrator is often related to the

potential negative outcomes of reporting the firm’s true

financial performance. Financial statements are used by

shareholders to measure the performance of the firm versus

expectations. The results have a significant influence on the

company’s stock price. Executives’ job security and

financial compensation are often dependent on maintaining

strong financial performance and rising stock prices. Thus,

top managers feel tremendous pressure to meet or exceed

investors’ expectations and may even consider using

fraudulent means to do so.

The second element of the fraud triangle is that of

opportunity. Perpetrators need to perceive that there is a

realistic opportunity to commit the fraud without facing

grave consequences. Opportunity is largely about per-

ceiving that there is a method for perpetrating the fraud that

804 C. Albrecht et al.


is undetectable. A person that perceives a reasonable

opportunity for fraud typically senses that he or she will not

get caught, or it would be unlikely that anywrongdoing could

be proven. If an individual perceives such an opportunity, he

or she is much more likely to consider the possibility of

initiating unethical actions. Of course, shareholders or

boards of directors strive to reduce the perception of

opportunity by implementing systems and controls (e.g.,

auditing procedures) that make it more difficult to perpetuate

a fraud. However, some people, particularly executives with

considerable authority, may suppose that they can manipu-

late and control their environment in a way that will reduce

the likelihood of detection.

Rationalization is the third element of the triangle. Most

people are basically honest and have intentions to be eth-

ical. Thus, even the consideration of committing fraudulent

acts results in significant cognitive dissonance and negative

affect (Aronson 1992; Festinger 1957). In order to over-

come such dissonance, fraud perpetrators generally try to

find a way to reconcile their unethical cognitions with their

core values. As a result, they seek out excuses for their

thoughts, intentions, and behaviors through logical justifi-

cation so that they may convince themselves that they are

not violating their moral standards (Tsang 2002). Typical

excuses for financial statement fraud may include, ‘‘This is

our only option,’’ ‘‘Everybody is doing it,’’ ‘‘It will only be

short-term,’’ or ‘‘It is in the best interest of the company,

shareholders, or employees.’’ Such rationalizations aim to

reduce the perception of unethicality or to shift the balance

of the equation to a more utilitarian ‘‘it may not be ideal,

but it is for the greater good.’’

Classical fraud theory suggests that fraud is most likely

to take place when all three elements are perceived by the

potential perpetrator. However, the three factors work

together interactively so that if more of one factor is

present, less of the other factors need to exist for fraud to

occur (Albrecht et al. 1981). It is also important to note that

the theory is based on perceptions. In other words, the

pressures and opportunities need not be real, only per-

ceived to be real.

Collusion between Perpetrators

Recent research into financial statement fraud has sug-

gested that nearly all financial statement frauds are per-

petrated by multiple players within the organization

working together (The Committee of Sponsoring Organi-

zations of the Treadway Commission 2002; Association of

Certified Fraud Examiners 2012; Zyglidopoulos and

Flemming 2008, 2009; Burke 2010). As such, it is neces-

sary to understand the relationship that takes place between

the initial perpetrator of a fraudulent act and any additional


Research on the perpetuation of fraud in organizations

has focused on diffusion (Strang and Soule 1998; Baker

and Faulkner 2003), social networking (Brass et al. 1998)

and the normalization of deviant practices (Earle et al.

2010). While each of these studies has enhanced our

understanding of fraud in organizations, there remains a

significant gap in our knowledge regarding how individuals

are influenced to join a fraudulent scheme. In others words,

we still do not know the processes by which one individ-

ual—after he or she has become involved in a financial

statement fraud—recruits other individuals to participate.

While the fraud triangle explains why a single individual

becomes involved in financial statement fraud, the theory

does not inform us as to how large groups of individuals

become involved. The fraud triangle is limited in that it

only provides a psychological glimpse of a single person’s

perceptions, and why he or she may choose to participate in

fraudulent behavior through pressure, opportunity, and

rationalization. We build on this theory by considering how

the leading perpetrator may influence the perceptions of

pressure, opportunity, and rationalization in a subordinate

during the recruitment process.

We start by presenting an illustrative strategic case of a

large public financial statement fraud. Next, we propose a

power-based, dyad reciprocal model to explain the process

of how collusive acts, particularly those of financial

statement fraud, occur in organizations. In so doing, we

offer propositions regarding how individuals within an

organization are oftentimes successfully recruited to par-

ticipate in financial statement scandals. We conclude with a

discussion and recommendations for future research.

Strategic Case: A Fortune 500, Billion-Dollar Fraud

In order to better understand how individuals are recruited

to participate in financial statement fraud, we investigated a

large financial statement fraud that recently occurred at a

U.S. ‘‘Fortune 500’’ company. At the time of the fraud, the

company was publicly traded on the New York Stock

Exchange and was considered to be one of the leading

growth companies in the United States. Because the fraud

is still under trailing litigation, we are not authorized to

disclose the name of the company. However, it should be

noted that the case is one of the well-publicized, financially

significant, financial statement frauds that occurred in the

United States over the last few years. By signing confi-

dentiality agreements, we were able to interview expert

witnesses and gain access to various court documents

including depositions, complaints, pre-trial motions,

amended complaints, and exhibits. We spent hundreds of

hours studying these documents.

In our investigation, we discovered that the financial

statement fraud started when significant financial pressure

The Role of Power in Financial Statement Fraud Schemes 805


was put on management, including the CFO and others.

Management was concerned that not meeting publicly

available earnings forecasts would result in significant

declines in the market value of the stock. By analyzing the

financial statements, it is possible to see the exact amount

that was manipulated each quarter in order to meet earnings

forecasts. In fact, in every quarter, management guided the

analysts to increasing earnings per share. Management

would then manipulate the financial statements in exactly

the amount needed to meet the consensus of the analyst’s

forecasted expectations. For example, if real earnings per

share were $.09, and Wall Street’s consensus expectation

was $.19 per share, management would manipulate the

statements to add $.10 per share for a total of $.19 per


The chief executive officer (CEO), the chief financial

officer (CFO), and the chief operating officer (COO) all felt

substantial pressure to meet the analyst’s forecasted

expectations for the organization. At first, management

used acceptable but aggressive accounting methods to

reach the desired numbers. When aggressive accounting

methods no longer achieved the desired targets, the top

management team pressured the CFO to do ‘‘whatever was

necessary’’ to meet the published numbers. The CFO was

left to himself to decide how to meet the objective. At first,

the CFO reached into future reporting periods to pull back

a few expected revenue transactions into the current period.

When that was no longer plausible, the CFO used ‘‘topside

journal entries’’ (accounting entries made to the trial bal-

ance with no support), false-revenue recognition, and

understatement of liabilities and expenses to perpetrate the


From our research, it is clear that while pressure came

from the CEO and COO, the CFO was the primary

manipulator of the financial statements. Unfortunately, we

could not (neither could the courts) determine how much

knowledge the CEO and COO had about the different types

of fraudulent financial transactions that were taking place.

However, in order to keep stock options valuable (the

CEO, COO, and CFO all had stock options worth tens of

millions of dollars) they were motivated to maintain high

stock prices by meeting Wall Street earnings expectations

every quarter.

Because so many people were involved in preparing the

financial statements of this large corporation, the need to

involve others in the fraud became necessary. The CFO

recruited the controller, the vice president of accounting,

the vice president of financial reporting, and the director of

financial reporting into the fraud. This ‘‘inner circle’’ of

perpetrators understood most elements of the fraud, and

recruited others to manipulate individual fraudulent trans-

actions (including various controllers at the company’s

subsidiaries). Subsidiary controllers then recruited others

within their own organizations to help perpetrate the fraud.

Though the number of people involved in the fraud

expanded over the years, the detailed knowledge of the

overall fraudulent behavior was generally limited to the

persons in higher level positions. Yet, even the principal

perpetrators hadn’t known how many people were actually

involved or the full extent of the financial statement losses.

Court documents suggest that those in the third and fourth

generations had very little knowledge of the scope of the

fraud, yet, still manipulated certain transactions that

enabled the fraud to be executed.

Court documents suggest that those who participated in

the fraud did so for various reasons. Several individuals,

especially those at the executive level, became involved

because they were promoted and received higher salaries.

Nearly all the participants received, as a result of a higher

stock price, more valuable stock options. Other individuals

participated because of fear of dismissal or reprisal. Third

and fourth generation participants, usually with little

knowledge of the overall scheme, participated because

their superiors told them to do something, or because they

felt they did not understand exactly what was going on.

Within the inner circle, individuals participated because

they trusted their colleagues and because, at first, the

fraudulent amounts were small. As a whole, the group

rationalized their actions as acceptable by making ‘‘seem-

ingly small rationalizations’’.

The total amount of the financial statement manipulation

was between $1 billion and $3 billion. Before the fraud was

discovered, more than 30 people participated in the fraud.

Many of these individuals had different levels of knowl-

edge regarding the fraud. While some of the perpetrators

had complete knowledge of the unethical acts that were

occurring, others performed tasks simply because they

were ‘‘asked to.’’ Those who had full knowledge of the

fraud rationalized their acts as acceptable. They believed

that the unethical financial statement manipulations would

only be necessary for a limited time. However, when reg-

ulators discovered the fraudulent financial statements, the

fraud had been occurring for over 4 years.

Power and the Decision to Commit Financial Statement


As illustrated in the case, fraud schemes are replete with

the use and abuse of power. Perceptions of personal power

and social power influence the initial decision to initiate the

financial statement fraud and also the recruitment of others

to assist and abet in the scheme. Personal power has been

described as the ability that a person has to carry out his or

her own will despite resistance (Weber 1947). Social power

is the ability to control the resources and outcomes of

others (Overbeck and Park 2001).

806 C. Albrecht et al.