Everlasting Fraud

Abstract

This paper proposes a new theory to explain why corporate fraud waves always resurface despite tough anti-fraud regulations. Our model offers two insights. First, the interdependent nature of fraud and regulation presents a cat-and-mouse equilibrium within-firm because detection strength optimally matches fraud severity. Second, it yields a whack-a-mole equilibrium across-firm because regulatory resources are optimally concentrated on the most fraudulent firms. Therefore, regulations cannot eradicate fraud but synchronize firms’ idiosyncratic fraud decisions, contributing to waves. These results carry strong policy implications by highlighting fraud as a permanent risk in the financial markets and the limited efficacy of anti-fraud regulations.

Keywords: Regulation, Financial Reporting, Accounting Fraud, Crime

JEL Classification: G32, G34, G38, M40, M41, M48