Managers’ Unethical Fraudulent Financial Reporting: The Effect of Control Strength and Control Framing

50 Pages Posted: 29 Jul 2014 Last revised: 19 Apr 2017

See all articles by Xiaotao Kelvin Liu

Xiaotao Kelvin Liu

Northeastern University - Accounting Group

Arnold Wright

Northeastern University - Accounting Group

Yi-Jing Wu

Texas Tech University - Rawls College of Business

Date Written: December 11, 2013

Abstract

In response to numerous recent cases involving materially misstated financial information arising from fraudulent financial reporting, companies, auditors, and academics have increased their focus on strengthening internal controls as a means of deterring such unethical behaviors. However, prior research suggests that stronger controls do not necessarily reduce the very opportunistic behavior the controls are intended to curb. The current study investigates whether the efficacy of an implemented control is conditioned on not only the strength of the control (weaker or stronger), but also on how the firm frames the purpose for implementing the control (e.g., monitoring or coordinating). A monitoring purpose frames controls as reducing managers’ opportunities to engage in self-interested behavior, while a coordinating purpose frames controls as facilitating coordination between the firm and its managers. We posit that the efficacy of stronger controls to reduce unethical fraudulent reporting depends on the control frame. Using an experiment, this study investigates the interactive effect of control strength and control frame on managers’ fraudulent reporting decisions. As predicted, our results show that when controls are framed for monitoring purposes, stronger controls result in less fraudulent reporting than weaker controls. Conversely, when controls are framed for coordinating purposes, stronger controls result in more fraudulent reporting than weaker controls. Our results suggest that an inconsistency between the firm’s choice of the control strength and the control frame reduces the efficacy of the implemented control to curb unethical reporting behaviors. Furthermore, supplemental analysis shows that managers’ rationalization helps explain the interactive effect of control strength and communicated control purpose on fraudulent reporting.

Keywords: Unethical behavior; Fraudulent financial reporting; Fraud triangle; Rationalization; Internal controls

JEL Classification: M41, M49, G31, G34

Suggested Citation

Liu, Xiaotao Kelvin and Wright, Arnold and Wu, Yi-Jing, Managers’ Unethical Fraudulent Financial Reporting: The Effect of Control Strength and Control Framing (December 11, 2013). Journal of Business Ethics 129 (2) June 2015, Available at SSRN: https://ssrn.com/abstract=2473452

Xiaotao Kelvin Liu (Contact Author)

Northeastern University - Accounting Group ( email )

404B Hayden Hall
360 Huntington Avenue
Boston, MA 02115
United States
617-373-5926 (Phone)

Arnold Wright

Northeastern University - Accounting Group ( email )

406 Hayden Hall
United States

Yi-Jing Wu

Texas Tech University - Rawls College of Business ( email )

703 Flint Avenue
Lubbock, TX 79409
United States
216-368-8895 (Phone)

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