Keeping up with the Joneses: A Model and a Test of Collective Accounting Fraud

33 Pages Posted: 12 Dec 2007

See all articles by Nuno Fernandes

Nuno Fernandes

University of Navarra, IESE Business School; European Corporate Governance Institute (ECGI)

José Correia Guedes

Catholic University of Portugal (UCP) - Faculty of Economic Science and Business Studies

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

This paper explains the variations in incidence of accounting fraud across economic settings by putting the behavior and motivation of managers under the microscope. To safeguard their reputation in the managerial labor market, managers of firms that perform poorly are prone to fraudulently inflate earnings if they expect the economy to be strong, since that raises the likelihood of peers reporting high performance. A realized level of economic activity, on the other hand, counteracts this tendency on the part of managers to manage earnings, by reducing the number of firms that actually perform poorly. We term these two effects the incentive effect and the need effect, respectively. The existing literature on the incidence of accounting fraud has not considered the distinct influences of the expected and the realized levels of economic activity on the behavior of managers seeking to protect their reputation. Although the health of the aggregate economy affects the performance of all firms, this desire of managers to keep up with their peers entails a characteristic relationship between the incidence of accounting fraud and macroeconomic conditions. Specifically, the fraction of firms fraudulently overreporting earnings is positively related to expected economic performance and negatively related to realized economic performance.

These two macro effects on collective fraud are examined empirically by relating proxies of the aggregate incidence of accounting fraud to expected and realized GDP growth rates. The results unambiguously support the predicted influence of macroeconomic performance.

Keywords: earnings manipulation, fraud, corporate governance

JEL Classification: G34, G38, F36, M41, M43, H25, E44

Suggested Citation

Fernandes, Nuno and Correia Guedes, José Filipe, Keeping up with the Joneses: A Model and a Test of Collective Accounting Fraud (November 2007). Available at SSRN: https://ssrn.com/abstract=1063621 or http://dx.doi.org/10.2139/ssrn.1063621

Nuno Fernandes (Contact Author)

University of Navarra, IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

José Filipe Correia Guedes

Catholic University of Portugal (UCP) - Faculty of Economic Science and Business Studies ( email )

Lisboa, 1600
Portugal

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