Fraudulent Financial Reporting: Consideration of Industry Traits and Corporate Governance Mechanisms

TLDR

The fraud techniques used vary substantially across industries, with revenue frauds most common in technology companies and asset frauds and misappropriations most common in financial‑services firms. The study examines financial statement fraud in technology, health care, and financial services, comparing fraud firms to no‑fraud benchmarks and updating knowledge of fraud techniques and risk factors across these industries. Fraud firms in technology, health care, and financial services exhibit weaker governance—fewer and less independent audit committees, less independent boards, fewer audit committee meetings, and weaker internal audit support—than no‑fraud peers, underscoring the need for auditors to benchmark governance against industry standards.

Abstract

This paper provides insight into financial statement fraud instances investigated during the late 1980s through the 1990s within three volatile industries—technology, health care, and financial services—and highlights important corporate governance differences between fraud companies and no-fraud benchmarks on an industry-by-industry basis. The fraud techniques used vary substantially across industries, with revenue frauds most common in technology companies and asset frauds and misappropriations most common in financial-services firms. For each of these three industries, the sample fraud companies have very weak governance mechanisms relative to no-fraud industry benchmarks. Consistent with prior research, the fraud companies in the technology and financial-services industries have fewer audit committees, while fraud companies in all three industries have less independent audit committees and less independent boards. In addition, this study provides initial evidence that the fraud companies in the technology and health-care industries have fewer audit committee meetings, and fraud companies in all three industries have less internal audit support. This study of more current financial statement fraud instances contributes by updating our understanding of fraud techniques and risk factors in three key industries. Auditors should consider the industry context as they evaluate the risk of financial fraud, and they should compare clients' governance mechanisms to relevant no-fraud industry benchmarks.