Pamela R. Murphy

Attitude, Machiavellianism and the Rationalization of Misreporting

Audit standards around the world describe three factors, known together as the fraud triangle, that purportedly predict the likelihood of fraudulent financial reporting (IAASB, 2009; PCAOB, 2005). The first two factors, opportunity and incentive/pressure, are largely accepted as being associated with fraud (Erickson, Hanlon, & Maydew, 2004; Graham, Harvey, & Rajgopal, 2005; Wells, 2001), whereas the third factor, attitude/rationalization, remains a relative mystery (Hogan, Rezaee, Riley, & Velury, 2008; Wells, 2004). I conducted an experiment in which participants were provided the opportunity and motivation to misreport, in order to explore attitude and rationalization in greater detail. As expected, I found that participants whose attitude favors misreporting and individuals who are higher in Machiavellianism are both more likely to misreport; and participants who misreport experience negative emotions (affect). Of concern, however, is that higher Machiavellians who misreport feel significantly less guilt than others who misreport. When I changed the experimental setting and asked participants to think about common rationalizations they may use, in an attempt to reduce rationalizing before they made their reporting decision, significantly fewer participants misreported; while those who still misreported rationalized to an even greater extent. Implications for future research and fraud detection and prevention are discussed.

The Impact of Ethics Education on Reporting Behavior

We examine the impact of an ethics education program on reporting behavior using two groups of students: fourth year Masters of Accounting students who just completed a newly instituted ethics education program, and fifth year students in the same program who did not receive the ethics program. In an experiment providing both the opportunity and motivation to misreport for more money, we design two social condition treatments – anonymity and public disclosure – to examine whether or to what extent ethical values are internalized by students. We find that when participants are anonymous, misreporting rates are nearly the same regardless of ethics program participation. However, when their reporting behavior is made public to the cohort, participants who completed the ethics program misreported at significantly lower rates than those who did not receive the ethics program. The results suggest that ethics education does not necessarily result in internalized ethical values, but it can impact ethical behavior.

The Impact of Authority on Reporting Behavior, Rationalization and Affect

We examine reporting choices, rationalizations and emotional responses when an authority figure directs participants to misreport the results of their performance for financial gain. Our research is motivated by the assertions of several individuals involved in major accounting scandals that an authority figure instructed them to perpetrate fraudulent financial reporting. We employ a laboratory experiment where a “boss” instructs participants to misreport for financial benefit. We find that, when instructed to misreport: (1) more participants misreport, (2) they rationalize their behavior primarily by displacing responsibility, and (3) they do not feel as badly as they do when they misreport on their own volition. We find that displacing responsibility mediates the relation between being told to misreport and the act of misreporting, resulting in lower levels of negative affect. Our research addresses calls to better understand the role of rationalizations in fraudulent reporting (Hermanson 2009) and lays the groundwork necessary to explore interventions that reduce fraudulent financial reporting (AICPA 2002, Wells 2004).

Can Fraudulent Cues Be Transmitted by Innocent Participants

ABSTRACT The authors explore whether and how linguistic indicators of fraud make their way into the Management Discussion & Analysis (MD&A) section of financial reports. Although research has shown that word choice and tone can help identify fraudulent financial reports, it is as yet unclear how this occurs when these reports are written by many individuals, some of whom are unaware that financial misrepresentation is occurring. Through an examination of industry recommendations and interviews with individuals experienced in writing the MD&A section, the authors confirm that many hands are involved in drafting this portion of financial reports. The authors then structure an experiment, using a real fraud case, that asks participants to write an MD&A from truthful prior U.S. Securities and Exchange Commission filings and a memo from the CFO with suggestions of what to say in the current period MD&A. Unbeknownst to participants the CFO memo was created using phrases from financial statements subsequently identified to be fraudulent. The authors find that individuals do unwittingly write MD&A associated with fraudulent financial statements with relatively little suspicion and that linguistic cues contained in the CFO memo are transmitted to the ultimate MD&A through naive and innocent participants.

Why are People Honest? Internal and External Motivations to Report Honestly

We create and validate measures capturing internal and external motivations to report honestly as individual differences. Both measures have high levels of reliability, as well as convergent and divergent validity. To test their predictive validity, we conduct two experiments. In the first, MTurk participants have the opportunity and incentive to misreport with no immediate consequences, and in the second, participants with management experience report how they would act in a similar business context. We find that participants who are higher in internal motivations to report honestly are, indeed, more likely to report honestly than others. Partial evidence supports that people higher in external motivations report more honestly when we introduce management controls. We also provide evidence of unintended consequences; people who are higher in internal motivations actually misreport more under certain controls than they do absent those controls, consistent with self-determination theory. Results should be of interest to management and those charged with governance or oversight within an organization. Our measures are also useful to researchers investigating honest reporting by allowing them to identify, ex ante, individuals who wish to be honest versus appear honest.