Psychological Pathways to Fraud: Understanding and Preventing Fraud in Organizations

Abstract

In response to calls for more research on how to prevent or detect fraud (ACAP, 2008; AICPA, 2002; Carcello et al., 2008; Wells, 2004), we develop a framework that identifies three psychological pathways to fraud, supported by multiple theories relating to moral intuition and disengagement, rationalization, and the role played by negative affect. The purpose of developing the framework is twofold: 1) to draw attention to important yet under-researched aspects of ethical decision-making, and 2) to increase our understanding of the psychology of committing fraud. Our framework builds on the existing fraud triangle (PCAOB, 2005) which is used by auditors to assess fraud risk. The fraud triangle is composed of three factors that, together, predict the likelihood of fraud within an organization: opportunity, incentive pressure, and attitude rationalization. We find that, when faced with the opportunity and incentive pressure, there are three psychological pathways to fraud nestled within attitude rationalization: 1) lack of awareness, 2) intuition coupled with rationalization, and 3) reasoning. These distinctions are important for fraud prevention because each of these paths is driven by a different psychological mechanism. This framework is useful in a number of ways. First, it identifies certain insidious situational factors in which individuals commit fraud without recognizing it. Second, it extends our knowledge of rationalization by theorizing that individuals use rationalization to avoid or reduce the negative affect that accompanies performing an unethical behavior. Negative affect is important because individuals wish to avoid it. Third, it identifies several other methods fraudsters use to reduce negative affect, each of which could serve as potential “psychological red flags” and helps predict future fraudulent behavior. Finally, our framework can be used as a theoretical foundation to explore several interventions designed to prevent fraud.

Keywords: fraud, fraud triangle, rationalization, negative affect, moral intuition, moral reasoning

JEL Classification: M4''8 M41