Clinging Onto the Cliff: A Model of Financial Misconduct

USC Marshall School of Business Research Paper Sponsored by iORB, No. Forthcoming

Boston University Questrom School of Business Research Paper Forthcoming

Boston Univ. School of Law Research Paper Forthcoming

52 Pages Posted: 1 Feb 2022 Last revised: 16 Aug 2022

See all articles by AJ Chen

AJ Chen

University of Southern California - Marshall School of Business

Suk Lee

University of Southern California, Marshall School of Business

Fernando Zapatero

Questrom School of Business, Boston University

Date Written: August 15, 2022

Abstract

We propose a novel pressure-based model of financial misconduct. We interpret the robust empirical findings of a high “success rate of crime” as evidence of skewness in the payoff of white- collar crime. Our model proposes skewness-seeking as a key driver of financial misconduct, as opposed to the conventional analysis that postulates (an empirically elusive) positive expected payoffs associated to crime. In our model, criminal motives arise as optimal responses to a “tunnel vision” that engrosses firm managers, whereby the intense pressure to attain the focused goal triggers strong demand for negatively skewed bets in the form of crime. We show results that are consistent with the notion of a “slippery slope to crime” that is finding growing support in the literature as well as in practitioner accounts. Comparative static analyses on the model also reveal several empirical implications –for example, a “pecking order of crime” indicating that serious infringements will only follow the depletion of the more preferred (and possibly prevalent) option of milder incursions of law, e.g., minor violations of financial reporting standards– many of which find empirical support in the literature.

Keywords: Financial Misconduct, Skewness Seeking Behavior, Financial Reporting, Accounting Fraud, White-collar Crime, Binomial Martingales, Becker Model of Crime

Suggested Citation

Chen, AJ and Lee, Suk and Zapatero, Fernando, Clinging Onto the Cliff: A Model of Financial Misconduct (August 15, 2022). USC Marshall School of Business Research Paper Sponsored by iORB, No. Forthcoming, Boston University Questrom School of Business Research Paper Forthcoming, Boston Univ. School of Law Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=3964115 or http://dx.doi.org/10.2139/ssrn.3964115

AJ Chen

University of Southern California - Marshall School of Business ( email )

Los Angeles, CA
United States

Suk Lee (Contact Author)

University of Southern California, Marshall School of Business ( email )

Los Angeles, CA
United States

Fernando Zapatero

Questrom School of Business, Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
617-353-3631 (Phone)

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