Top Management Fraud

Journal of Management / December 2005
ARTICLE
10.1177/0149206305279598
The Antecedents and Consequences

of Top Management Fraud
Shaker A. Zahra*
Carlson School of Management, University of Minnesota,
321 19th Ave. South, Minneapolis MN 55455
Richard L. Priem
School of Business Administration (S387), The University of WisconsinMilwaukee,
Milwaukee, WI 53201
Abdul A. Rasheed
Department of Management, College of Business Administration,
University of Texas at Arlington, Arlington, TX 76019
Fraud by top management is a topic that has stirred public interest, concern, and controversy. In
this article, the authors analyze fraud by senior executives in terms of its nature, scope, antecedents, and consequences. They draw on the fields of psychology, sociology, economics, and criminology to identify societal-, industry, and firm-level antecedents of management fraud and the
individual differences that enhance or neutralize the likelihood and degree of such fraud. The
authors also review the consequences of management fraud on various stakeholder groups such as
shareholders, debtholders, managers, local communities, and society.
Keywords:
top management fraud; antecedents of fraud; consequences of fraud; financial

misstatements; malfeasance
Zahra et al. / Top Management Fraud
We are grateful for the extensive and supportive comments of Daniel Feldman and an anonymous reviewer. We
acknowledge with appreciation the research assistance and helpful comments of Tomasz Jasinski, Jeff Trachsel,
Patricia H. Zahra, and Pie Zhang.
*Corresponding author. Tel.: 612-626-6623; fax: 612-626-1316.
E-mail: szahra@earthlink.net, szahra@babson.edu
Journal of Management, Vol. 31 No. 6, December 2005 803-828
DOI: 10.1177/0149206305279598
2005 Southern Management Association. All rights reserved.
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Top management fraud has become a worldwide problem that cuts across ideological and
cultural divides. Recent corporate scandals have rocked the United States (e.g., Enron, Global
Crossing, and WorldCom), drawing attention to the prevalence and insidious effects of managerial fraud (Prentice, 2003). Asian (Ferguson & Majid, 2003), European (Jayne, 2003), Latin
American (Organization for Economic Cooperation and Development, 2005), African, and
Australian companies (KPMG Fraud Survey, 1999) also have been afflicted by top management fraud. There is a growing realization that fraud by senior managersoften, simply lying
for moneyis more widespread than previously believed (Daboub, Rasheed, Priem, & Gray,
1995). Entrusted with protecting and increasing shareholders wealth, some executives have
devised elaborate schemes to defraud people who have invested in their companies. In the
United States, such fraud frequently has involved multiple individuals at different levels in the
organization and has prevailed for years despite external audits by professional companies and
monitoring by boards of directors staffed with a majority of outside directors.
Management fraud in the United States has increased despite nearly three decades of sustained efforts to reform corporate governance, to use effective compensation systems to better
align managers and shareholders interests, and to institutionalize codes of conduct that
improve managers ethical performance (Berenson, 2003). Legal and professional codes also
have evolved to protect the public and ensure responsible management (Hansen, McDonald,
Messier, & Bell, 1996). Some believe, however, that management fraud has become so sophisticated that auditors seldom discover it (e.g., Hansen et al., 1996). Others even argue that the
laws and regulations enacted to protect shareholders interests have become so complicated
that they actually contribute to the growing incidence of top managerial fraud (Berenson, 2003).
In this review, we define types of fraudulent behavior by top managers, linking them to
white-collar crimes. We then identify key societal, industry, organizational, and individual
variables that contribute to such behavior. To do so, we draw on theories from criminology,
psychology, sociology, and economics. Next, we analyze societal, industry, and organizational effects of top management fraud. The final section of the article suggests important
avenues for future research.
Top Management Fraud

Fraud refers to the deliberate actions taken by management at any level to deceive, con,
swindle, or cheat investors or other key stakeholders. Such fraud can take a variety of forms.
Moberg (1997) identified embezzlement, insider trading, self-dealing, lying about facts, failure to disclose facts, corruption, and cover-ups as some of these forms. Types of fraud can also
be specific to an industry. For example, in their study of the Savings and Loan (S&L) crisis of
the 1980s, Calavita, Tillman, and Pontell (1997) identified hot deals (land flips, nominee
loans, reciprocal lending, linked financing), looting (siphoning off funds by thrift insiders),
and covering up (hiding insolvency) as the three major types of managerial fraud that led to the
S&L debacle. A significant number of recent instances of managerial fraud take the form of
intentional misrepresentation of amounts or disclosures in the financial statements
(Apostolou, Hassell, & Webber, 2000: 181). Managers might also create schemes to hide or
misrepresent what the firm does or how the firm does it. A key word in this definition is
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intentionality, where senior managers willfully undertake actions that materially mislead others about the real value of the firms assets, transactions, or financial position (Beasley, 1996).
Fraud schemes vary considerably in scope, with some being limited to one or a few transactions (e.g., falsifying a document), whereas others encompass multiple, ongoing activities
across many organizational functions or units. For instance, Adelphia Communications
founding family was accused of fraud when it collected $3.1 billion in off-balance-sheet loans
that were backed by the company. The family also was accused of overstating the companys
financial results by inflating capital expenditures and hiding debt. Enron, on the other hand,
developed an elaborate pyramid-like scheme of new businesses that supposedly generated
new revenues and profits that did not actually exist. The schemes that senior managers use
when they commit fraud also vary in their magnitude. Some affect only particular units or divisions, whereas others permeate all the firms operations, as happened in the case of Enron.
Fraud schemes also vary in their duration: The Enron and Worldcom frauds each persisted
more than a decade.
Top Management Fraud as a White-Collar Crime

In this article, we focus on fraud committed by top managers. Such wrongdoing in and by
corporations has been the subject of study in disciplines as varied as management, accounting,
psychology, criminology, economics, and law. Researchers have used numerous labels to
describe this phenomenon, such as white-collar crime, corporate wrongdoing, management
fraud, managerial vice, and corporate illegal behavior. The absence of physical violence, the
existence of strong financial motivations, and the involvement of individuals who are otherwise considered respectable members of society are characteristics of white-collar crimes. A
white-collar crime is committed by a person of respectability and high social status in the
course of his occupation (Sutherland, 1949: 9). Such a crime is defined simultaneously by
characteristics of the offender (i.e., high status) and of the offense itself (i.e., work related).
White-collar crimes could be classified in several ways. Clinard and Quinney (1973)
focused on characteristics of the offense itself in differentiating occupational from corporate
crimes. Occupational crimes are those committed against a firm for the benefit of the individual perpetrator and might include embezzlement or padding expense reports. Corporate
crimes, however, are committed by the perpetrator for the benefit of the corporation.
Braithwaite, for example, defined corporate crime as conduct of a corporation, or of employees acting on behalf of a company, which is proscribed and punishable by law (1984: 6).
These crimes might include bribery or pollution control violations. Corporate crimes help
the firmfor example, to obtain a contract or reduce costsbut these crimes may also lead to
indirect benefits for the perpetrator, such as promotions or pay increases. Thus, there are
white-collar crimes in which an individual perpetrator is the sole beneficiary and the firm is
the victim, in which the firm is the beneficiary and others in society are the victims, and finally
in which both the firm and the individual acting on behalf of the firm are beneficiaries and
others in society are the victims.
White-collar crimes can also be classified according to the extent of individual involvement
in the crime. Daboub et al. (1995) distinguished between active participation and passive
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acquiescence. In the first case, individuals are actively involved in an illegal activity, whereas
in the latter case, managers are aware of illegality within the organization but are unwilling to
take corrective action. A third type of illegal actions is crimes of obedience (Kelman & Hamilton, 1989). Here, the individual is caught in the dilemma of either carrying out a directive that
is wrong or disobeying an order and suffering the consequences. A fourth type of illegality,
referred to by Hamilton and Sanders (1999) as the second face of evil, is the result of actions
of individuals who occupy positions in organizational hierarchies and make decisions following established organizational routines, but where collectively these decisions escalate into
either massive cover-ups or disasters. These illegal or disastrous outcomes are frequently the
results of mistakes embedded in the banality of organizational life (Vaughan, 1996: 14),
despite the absence of negligence or intention. Finally, there are errors of negligence or
omission that result in harm.
The above discussion suggests that management fraud can occur as part of either occupational or corporate crime, can be perpetrated by those at the very top or the very bottom of the
managerial hierarchy, and can result from active participation or passive acquiescence. CEOs,
for example, might actively divert corporate funds for their own use or might knowingly stand
aside while others in their firms market unsafe products. First-line supervisors, similarly,
could steal from cash registers or might ignore subordinates who lie about unnecessary repairs
to inflate customer bills. Such crimes can be committed by executives of business firms, managers of public sector companies, civil servants, or elected officials. Extensive reviews of corruption by government officials and their consequences are available in Shleifer and Vishny
(1993) and Mauro (1995).
In this article, we focus on fraud by top managersa subset of white-collar crime that we
believe is particularly important to management researchers for several reasons. Notably, top
management fraud often is highly consequential for a firms shareholders and employees and
can even ruin the firm. Furthermore, top managers attitudes and actions toward fraud can promote similar behaviors by others throughout the firm. In addition, fraud by top managers is
truly shocking to many people, as in the recent mutual fund scandals, because it represents a
serious betrayal of trust by those who supposedly have been selected specifically for their
leadership, ability, and character. Management fraud is often committed by highly successful
people who already have made it but who can lose nearly everything if the fraud is discovered. This leads to the question: Why in the world do such accomplished senior executives do
it? The next section provides some answers to this complex question.
Antecedents of Top Management Fraud

Although the motivation to commit managerial fraud might be deeply embedded in top
managers personal ambitions, histories, and complex personality structures, several societal,
industry, and organizational factors might encourage and promote fraud. Therefore, Figure 1
highlights three sets of variablesat the societal, industry, and company levelthat serve as
antecedents to top management fraud. Figure 1 also identifies individual characteristics that
affect the degree to which increasing pressures from society, the industry, or the organization
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Figure 1
A Framework for Examining Management Fraud
Individual Level
Moderators
Antecedents
Age
Experience
Education
Gender
Self-Control
Societal
Differential Association
Aspirations (Strain)
Industry
Culture, Norms, Histories
Investment Horizons
Concentration
Hostility
Dynamism
Heterogeneity
Managerial
Fraud
Effects
Occupational
Corporate
Shareholders
Society
Local Communities
Employees
Managers Reputations
Organization
Board Composition
Leadership
Organizational Culture
are likely to actually make the decision to commit fraud. Even though these three sets of antecedents and the individual-level moderators are often acknowledged in the literature, they
have not been systematically investigated empirically. Our review, therefore, seeks to bring
clarity into the potential effects of these variables on top management fraud. Figure 1 shows
the building blocks of our review.
Societal-Level Antecedents
Sociologists highlight the social nature of criminal behavior and have offered numerous
societal- or group-level theories to explain it. Most of these theories are based on an underlying cultural deviance idea: that all humans conform to the norms of their group and, thus,
crime results only when a subgroups norms conflict with those of the larger society regarding
the definition of what is or is not criminal behavior. Sutherlands (1949) differential association theory follows this cultural deviance tradition by arguing that the likelihood of criminal
behavior is increased through association with those who define criminal behavior favorably.
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Thus, criminal behavior is learned. Ermann and Lundman have further contributed to the deviance literature, positing that deviant solutions to organizational problems become part of the
fabric of institutional life (1996: 9).
At the broader societal level, anomie theory and its more modern version, strain theory
(Merton, 1938), propose that societal norms affect individuals aspirations for things like
material goods and other indicators of success. Individuals who are unable to achieve their
aspirations by conventional means experience strain and may seek to relieve this strain by
using deviant means to achieve their desired ends. This, of course, suggests a social class basis
for crime because those in lower social classes will experience more strain (because of poverty
or inequality) and thus are more likely to relieve their strain by turning to criminal behavior.
Cohens subculture theory (1955) and Cloward and Ohlins (1960) differential opportunity
theory are similar in their arguments: Those who are unable to gain status through conventional means may adopt the delinquent solution through illegal behavior. Conflict theory and
its Marxist versions see the conditions prevailing under capitalist political economies as
primary reasons for crime (Simon & Eitzen, 1993).
Together, these theories suggest potential societal explanations for fraud. White-collar
crimes committed by top managers, however, present a particularly difficult challenge to these
social class/poverty theories of crime because these theories are not effective in explaining
criminality by high-status individuals such as senior executives of the worlds largest corporations. Such individuals are well paid, are in the upper socioeconomic classes, and are likely to
experience little traditional strain. They are, however, subject to the strain of inflated
expectations, as we discuss later.
Industry-Level Antecedents
Even though societal and organizational factors might induce and even facilitate top managers fraud (Figure 1), industry variables are also likely to have a major effect by creating
conditions that pressure, encourage, or enable fraud. A significant body of research documents the effects of industry characteristics on top managers willingness and ability to commit illegal acts. For example, Baucus and Near found that knowing that a firm operates in a
given industry may be a good way to predict the likelihood of that firms engaging in illegal
behavior (1991: 28). Although most prior research does not speak directly to senior managersfraud, it could be useful in delineating potential industry factors that play a role in this context. Saksenas (2001) study directly links selected characteristics of a firms external environment to the incidence of management fraud, concluding that firms associated with fraud
operate in environments that differ significantly from those that do not commit fraud.
Apostolou, Hassell, Webber, and Sumnerss (2001) experimental study asked 140 auditors to
rate the relative importance of 25 risk factors (red flags) embodied in SAS NO 82 (SAS is the
U.S. Auditing Standard Boards Statement on Auditing Standards, issued in 1996, governing audits regarding potential fraud in financial statements). Their analyses indicated that
challenging industry conditions are believed to trigger fraud.
Several other industry-related factors might influence the incidence of management fraud
(Figure 1). These factors include industry cultures, norms, and histories; industry investment
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horizons, payback periods, and financial returns; industry concentration; environmental hostility; environmental dynamism; and environmental heterogeneity. We discuss these variables
in turn next.
Industry cultures, norms, and histories. Over time, industries develop unique histories and
norms that shape company, managerial, and individual behaviors. In those industries where
fierce competition prevails, pressures to commit fraud might intensify. The aircraft manufacturing industry is an example of this competitive landscape. Conversely, in industries where a
norm of reciprocity and collaboration prevails, managers may be less pressured to commit
fraud. For example, interfirm collaboration is widespread in the biotechnology industry,
where companies usually face long development and regulatory approval cycles. Confronted
with huge development costs and limited resources, companies have found alliances to be useful in reducing uncertainty in their R&D and other aspects of their operations. Collaboration
helps reduce the odds of failure in new product development and improves companies
financial performance, thus lowering the incidence of management fraud.
Industries vary also in their experiences with management fraud. A survey of the airline
industry reported several hundred incidents of fraud in the preceding 12-month period
(KPMG International Fraud Report, 1996). These acts of fraud were committed by employees and management. Other industries have long histories of managers accepting bribes and
working around existing laws and regulations. The petroleum refining, transportation equipment (Baucus & Near, 1991), financial services, and health care industries have had a history
of committing illegal acts and therefore might be more tolerant of managerial fraud. Becker
(1964) observed that individuals who are self-interested usually weigh the cost of their crime
against potential penalties and punishment. The extent to which prior fraud violations committed in the industry have not been severely punished might play a role in managers
contemplation of and actually committing fraud.
Industry investment horizons, payback periods, and financial returns. Expectations regarding payback periods, time horizons, and acceptable return rates vary also from one industry to
the next. The pharmaceutical industry is accustomed to longer investment horizons coupled
with high payback from successful products. In the software industry, where upgrades are
introduced constantly, investment horizons are much shorter and depending on the class of the
software products, lower margins are expected. These norms influence stock analysts forecasts of a companys financial performance, which in turn pressure managers to smooth their
earnings and, worse, commit fraud. Given that what constitutes fraud is socially defined,
whether practices such as earnings management through smoothing can be considered as
fraud may be open to debate.
Irrational expectations might also take hold of the industry, analysts, and investors (Shiller,
2001). These expectations indicate a belief that new technology or new economy-type industries generate much higher returns than traditional technologies or sectors of the economy.
Irrational expectations reflect exaggerated expectations of much higher profits than what
would be a reasonable rate of return. When such irrational expectations become the norm
among investors and analysts, senior executives feel the pressure to commit fraud by
artificially overstating results.
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The accounting literature offers evidence that CEOs have financial incentives to meet earnings expectations. Boschen, Duru, Gordon, and Smith (2003), for example, have shown that
unexpectedly good stock performance increases the long-run cumulative financial gains of
CEOs. Matsunaga and Park (2001) have also shown that CEOs cash bonuses suffer if their
firms fall short of quarterly earnings forecasts. Perhaps not surprisingly, Payne and Robb
(2000), Brown (2001), and Matsumoto (2002) all found that senior executives make efforts to
avoid negative earnings surprises; CEOs have much to lose if their firms fail to meet
expectations.
Industry concentration. A key tenet of the free market system is that competition disciplines management and encourages innovation and entrepreneurial risk taking that creates
growth and improves profitability. When the industry becomes concentrated (i.e., dominated
by a few firms), the possibility of collusion increases. As industries become more concentrated, collusion among companies becomes possible and sometimes enduring. Large companies that dominate these industries can use their resources to influence regulators, escaping
public scrutiny (for a review, see McKendall & Wagner, 1997). Still, some researchers observe
that lower or moderate levels of industry concentration encourage the commission of illegal
acts because it is difficult to follow each of these firms and observe their financial operations
closely. Posner (1970), however, found no relationship between industry concentration and
corporate commission of illegal acts. Finally, although McKendall and Wagner (1997)
reported a positive but insignificant relationship between industry concentration and the commission of illegal acts, they found that the ethical climate in the firm attenuated the effect of
industry concentration on the commission of illegal acts.
To summarize, the preceding discussion highlights the difficulty that researchers encounter
in linking industry concentration to corporate commission of illegal acts. As an industrys
concentration increases, both the incentives and opportunities for top management to commit
fraud are likely to increase. Executives realize that it is more difficult and costly for companies
to acquire higher market share and profitability as industry concentration rises.
Environmental hostility. Environmental hostility refers to the unfavorability of a firms
major industrys competitive conditions. Hostile environments are characterized by low or
declining demand, strict regulatory rules, intense competition, low profit margins, and a high
rate of organizational failures. Apostolou et al. (2001) reported that auditors believe that competing in a declining industry and increased regulations are two conditions that encourage
management fraud. Companies facing hostile environments often need to invest heavily in
product, process, and administrative innovation. Most of these investments, however, help the
firm to simply stay alive in an increasingly harsh, demanding, and unmanageable competitive
terrain.
Environmental hostility often reduces a companys sales growth and profitability, possibly
encouraging violations of antitrust laws (Szwajkowski, 1985). Baucus and Baucus (1997), for
example, found that companies that were convicted of illegal acts had experienced lower sales
growth during the prior 5 years than firms that were not convicted of these crimes. Hostile
environments also reduce any slack resources the firm might have and dampen its ability to
absorb any adverse effects on its operations (Staw & Szwajkowski, 1975). Cutthroat competi-
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tion thrives in hostile environments, promoting unethical behavior even among salespeople
(Robertson & Anderson, 1993). These unethical behaviors not only hide the truth about the
firms performance but also seek to match competitors unethical behavior (Robertson &
Anderson, 1993). Along these lines, Hansen et al. (1996: 1024) noted that the incidence of
management fraud is likely to be higher in declining industries or when bankruptcy is common, reinforcing the finding that firms in industries where performance is below the national
average will be characterized by more illegal acts (Staw & Szwajkowski, 1975).
Environmental hostility has other, indirect effects on managerial fraud. As hostility rises
and organizational performance deteriorates, some senior executives might centralize their
operations and restrict communication about the firms financial position or its performance.
This makes it difficult for outsiders to evaluate what is happening internally. As hostility
increases, investors often give executives the benefit of the doubt in managing adverse economic and competitive conditions. Increased centralization enables willing executives to
commit fraud without fear of immediate detection. Loebbecke, Eining, and Willingham
(1989) found that in 75% of the fraud cases they analyzed, a single person dominated operating and financial decisions, making it difficult to spot and stop managerial fraud in a timely
fashion. Overall, high levels of environmental hostility might encourage centralization that
gives senior executives the opportunity to commit fraud and conceal it from others.
Environmental dynamism. Technological advances, market changes, and competitive
moves reflect environmental dynamism, which refers to the speed and unpredictability of
change in a given industry. Dynamism creates opportunities that companies can exploit to
achieve profitability and growth by creating new businesses or acquiring companies in current
or new industries. Companies have to invest heavily in identifying these opportunities and create the infrastructure necessary to exploit them. These investments may lower a firms shortterm performance. Consistent with these observations, Hansen and colleagues (1996) have
concluded that when the industry is growing fast, the probability of managerial fraud increases.
Another reason for expecting higher incidence of top management fraud in dynamic industries is the increased specialization of the companys key personnel. As the firm expands its
operations, environmental dynamism allows each division or unit to work independently.
Fraudulent acts might be concealed by this growing differentiation of roles. As Baucus and
Near (1991) argued, differentiation leads companies to spread responsibilities among different individuals, and no single individual has enough information to spot or stop managerial
fraud. Indeed, using this logic, Baucus and Near (1991) reported a curvilinear relationship
between environmental dynamism and corporate commission of illegal acts of different types.
Firms competing in less dynamic environments or in highly turbulent environments were
more likely to commit illegal acts than those in moderately turbulent environments. We
believe the same logic applies to management fraud.
Environmental heterogeneity. Environmental heterogeneity can also influence the incidence of managerial fraud (Figure 1). When a firm competes in different markets, targeting
different customer groups who have divergent needs and expectations, its business environment is considered heterogeneous. This heterogeneity is a major source of complexity
because it is difficult for managers to predict changes in their firms external environments
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accurately or control the forces that lead to these changes. Heterogeneous environments are,
therefore, complex business settings. In these complex settings, with correspondingly complex organizational structures, it is hard to fully comprehend the various transactions a firm
might undertake. Thus, organizational complexity provides more opportunity for managers to
commit fraud. Indeed, Saksena (2001) found that companies experiencing management fraud
were characterized by greater environmental heterogeneity compared with organizations that
did not experience fraud. Interestingly, Baucus and Near (1991) have found that
environmental heterogeneity had a curvilinear relationship with the firms commission of
illegal acts.
Clearly, several industry variables might individually or jointly pressure senior managers
to commit fraud or might provide particularly attractive opportunities for those who wish to
undertake such fraud. Still, the paucity of empirical research on several industry antecedents
to top management fraud makes it difficult to draw concrete conclusions about the effects of
these variables. Furthermore, the few studies reported have not examined the effect of industry
variables on the severity or duration of fraud, leaving major gaps in our knowledge.
Firm-Level Antecedents
Jensen (1993) identified four firm-level factorsthree external and one internalthat
combine to promote effective corporate governance. These are legal and regulatory systems,
capital market (i.e., takeover) controls, competition in product and factor markets, and the
firms internal control systems. The internal controls are headed by the board of directors and
include leadership and culture. This section of the article covers these internal issues, starting
with the firms board: the apex of its governance system.
Board composition. A fundamental characteristic of modern corporations is the separation
of ownership and control. Stockholders of large publicly held corporations delegate decision
making to hired managers while diversifying their risk by owning a portfolio of securities
(Fama, 1980). This can create a free rider problem where no individual stockholder has a large
enough incentive to devote the resources necessary to monitor senior managers (Grossman &
Hart, 1980). Absent close monitoring by stockholders, some executives are apt to act opportunistically, enriching themselves or foregoing long-term value-creating activities such as
building the firms technological competencies through R&D.
The primary responsibility for monitoring top managers rests with the board of directors in
public corporations. As a result of shareholder activism (Neubaum & Zahra, in press) on one
hand and threat of litigation on the other hand, boards are increasingly transforming themselves from rubber stamps for managerial decisions into more active and vigilant monitors.
Agency theorists propose that boards that are dominated by outside directors who act independently from management are better positioned to monitor executives and curb their opportunistic behavior (Fama & Jensen, 1983; Zahra & Pearce, 1989).
Even though Kesner, Victor, and Lamont (1986) found no evidence that adding outsiders to
boards will lessen a firms likelihood to engage in illegal activities, Beasleys (1996) study
reported that firms committing financial statement fraud had fewer outside board members.
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Beasley also concluded that the likelihood of financial statement fraud decreased as outside
director ownership and outside director tenure increased. The presence of an audit committee,
surprisingly, did not make a significant difference. These findings supported the proposition
that outside directors became vigilant of managerial actions when directors had a vested interest in company performance (e.g., owning company shares or maintaining their tenure with
the company, which is a source of income). In a subsequent study, Beasley, Carcello,
Hermanson, and Lapides (2000) found that companies committing fraud had weaker governance mechanisms characterized by fewer audit committees, less independent audit committees and boards, and fewer audit committee meetings. Consistent with these findings, Figure 1
suggests that board of directorscomposition can influence the incidence of managerial fraud.
The accounting literature also has identified several potential predictors of financial statement fraud such as rapid company growth, auditor change, a commitment to achieve unrealistic forecasts, and insider trading (Summers & Sweeney, 1998). Of these, rapid company
growth is considered as a significant red flag fraud indicator (Loebbecke et al., 1989). That
is, if reported growth is too rapid, it may well be the result of financial manipulation rather than
actual growth. If the company is facing financial distress, senior executives may place undue
emphasis on earnings and profitability, possibly increasing the likelihood for financial statement fraud. The National Commission on Fraudulent Financial Reporting (American Institute
for Certified Public Accountants, 1987: 29) suggests that new public companies are more
likely to be involved in financial statement fraud because senior management is under
considerable pressure to meet earnings expectations.
Accounting research, by and large, has focused on identifying potential indicators or red
flags rather than establishing direct causes or antecedents. However, one antecedent factor
that has attracted the attention of accounting researchers is the role compensation plans play in
spurring self-serving or even fraudulent decisions by CEOs. For example, Barton (2001)
found that managers in a sample of Fortune 500 firms purposely managed earnings to increase
their cash compensation, whereas Guidry, Leone, and Rock (1999) provided evidence that
earnings management is associated with CEOs bonuses (see also Healy, 1985; Hirst, 1994).
Similarly, DuCharme, Malatesta, and Sefcik (2001) reported that managers manipulate earnings to increase their proceeds from initial public offers (IPOs), at the expense of investors. In
sum, the accounting literature indicates that senior executives sometimes make company
decisions to maximize their own wealth.
There are conflicting views on how stock ownership by board members and senior executives affects financial statement fraud. Agency theory (Fama & Jensen 1983) suggests that
stock ownership by management can reduce agency problems. Yet, Loebbecke et al. (1989)
argued that stock ownership by executives motivates them to inflate stock prices by fraudulent
financial reporting. The concentration of power in the hands of the CEO could facilitate financial statement fraud (Dunn, 2004). Such concentration of power is often reflected in the CEO
also serving as board chairperson or having long-term tenure on the job. Beasley (1996) found
that the likelihood of financial statement fraud decreases as directors stock ownership
increases and outside directors tenure on the board increases.
Senior leadership. The ethical climate of an organization is set by or significantly influenced by the actions of top management, especially the CEO. Ethical leadership encourages
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analysis and critical evaluation of those who are in power. It also sets a norm of honesty
throughout the organization. When leaders who espouse ethical values are in charge, one
would expect top management fraud to be limited, if not extinct. However, when leaders do
not follow these ethical values, fraud might become more widespread. Even when the CEO
does not engage in wrongdoing, he or she can still encourage it by rewarding, condoning,
ignoring, or covering up (Baucus, 1994). Ashforth and Anand (2003) noted that the role of the
CEO becomes even more significant in cases where the CEO is charismatic, a quality that
leads to greater identification, trust, and reflexive obedience by subordinates. In this case, subordinates are likely to emulate the CEOs behavior. Charismatic leaders are often able to build
coalitions of followers who do not question their actions or fail to probe their leaders failings.
These leaders are skilled in silencing dissent and critical evaluation, neutralizing their enemies. When these leaders are at the helm of organizations and commit fraud, it is hard for
employees to come forward and blow the whistle on their leaderscorrupt behaviors. Thus, top
leaderslack of commitment to ethical behavior could encourage and facilitate fraud (Figure 1).
Interestingly, as we reviewed the literature on the effect of leadership on top management
fraud, we were struck by the lack of serious and persuasive empirical analyses of this issue.
This came as a surprise to us, given the voluminous literature on leadership and the abundance
of anecdotal evidence on the role of ethical values (or lack thereof) and charismatic leadership
in organizational crises. Indeed, Berensons (2003) book is replete with stories of how charismatic leaders were able to consolidate their powers, to introduce fraudulent schemes, and to
use their personal magnetism to mislead others in and outside their companies. These leaders
also shape their firms cultures.
Organizational culture. Over time, some organizations develop deviant cultures in which
wrongdoing is rationalized and institutionalized. Some scholars, who focus primarily on corporate crime, argue that such businesses organizational cultures imbue lawbreaking with the
normative status of business as usual and thus produce criminal behavior in white-collar settings (e.g., Reed & Yeager, 1996). Enron and BCCI are two prime examples. Another recent
example of this situation is the case of Columbia/HCA and other hospital chains arguing that
keeping two sets of booksone aggressive set to submit to Medicare and one conservative set as a fallbackwas a common industry practice.
Trice and Beyer (1993) identified several characteristics that lead to the emergence of
strong subcultures: high within-group task interdependence and low between-group interdependence, accountability for performance goals but not means, group-based versus individual-based rewards, member stability and cohesion, peer-based socialization, and physical
proximity. Ashforth and Mael (1989) explained the prevalence of unethical subcultures as the
result of compartmentalization of identities. That is, a subculture holds values that are apart
from the overall social norms and even individual ethical norms by applying the deviant values
only in the context of their subcultural identity. Conversely, some organizations develop positive ethical climates that reduce the likelihood of fraudulent actions. McKendall and Wagner
(1997), for instance, found that strong ethical climates neutralize the relationships between
industry or organizational factors and the illegal behavior of environmental violations.
815
Individual-Level Moderators
We have just seen how societal, industry, and firm characteristics would likely affect the
incidence of top management fraud. Society, for example, establishes an individuals values
through both aspirations and associations (Merton, 1938; Sutherland, 1949). At the industry
level, highly concentrated industry structures, resource scarcity, and rapidly changing environments all have been found to be antecedents of various corporate illegalities (Daboub et al.,
1995; McKendall & Wagner, 1997). Organizational-level variations, such as firm size and
organizational slack, also influence the likelihood of white-collar crime. Larger companies are
more complex and often decentralize their operations, providing an opportunity for illegal acts
while reducing chances of detection (Baucus & Near, 1991; McKendall & Wagner, 1997).
Furthermore, top managers at firms with little or no organizational slack may feel that they
must commit illegal actions just to survive (Baucus & Near, 1991; Daboub et al., 1995).
Yet, the commission of fraud at the highest levels in organizations ultimately involves individual decisions to participate or acquiesce. This leads us directly to the consideration of individual-level factors that might affect the incidence of managerial fraud. In Figure 1, we show
the individual-level factors as neutralizing or enhancing variables (Howell, Dorfman, &
Kerr, 1986: 89) that either weaken or strengthen the previously discussed relationships
between industry-level or firm-level antecedents and the incidence of top management fraud.
That is, rather than predicting fraud directly, the individual characteristics we discuss next can
affect the degree to which increasing pressures from society, the industry, or the organization
are likely to actually result in the decision to commit fraud or acquiesce when fraud is
observed. Figure 1 suggests that age, education, experience, gender, and self-control are
potentially important individual characteristics that have received some empirical support as
affecting the likelihood of managerial fraud given a particular industry and organizational
environment. Of these, the first four are demographic variables, whereas the last one is an
individual trait.
The use of demographic variables in top management team research is based on the argument that they are proxies for other underlying managerial traits (Hambrick & Mason, 1984).
They have been widely used in research, partly because demographic data are relatively easy
to collect. However, organizational demography research has come under increasing criticism
lately for inferences based on unmeasured variables (Lawrence, 1997), inability to suggest
actionable prescriptive conclusions (Priem, Lyon, & Dess, 1999), and relying entirely on
archival data (Pettigrew, 1992). Given the pervasiveness of these factors in the literature, we
address each of these individual-level factors next.
Age
Age influences individuals decisions concerning both common street crimes and whitecollar crimes (e.g., Shover & Hochstetler, 2002). Generally, youth is associated with risk seeking and with an inability to delay gratification or accurately evaluate long-term consequences
(Gottfredson & Hirschi, 1990). Maturity, on the other hand, has been found to be associated
816
with moral development, as shown by research findings that age is inversely related to
Machiavellianism and unethical decisions by marketers (Kelley, Ferrell, & Skinner, 1990).
Furthermore, managers increasing age is associated with deliberateness in decision making, seeking more information for the decision, more accurate diagnosis of the information
gathered, less confidence in being right, and greater willingness to reconsider (e.g., Child,
1974; Taylor, 1975). This suggests that older senior executives are less likely to make precipitous decisions under the sway of industry or organizational pressures, dampening the potential
relationships between industry and organizational factors and the incidence of top managers
fraud (Daboub et al., 1995).
Experience
Given its relationship with age, it is perhaps not surprising that experience may also influence the likelihood of corporate illegalities in particular industry and organizational environments (Figure 1). The simple length of a managers tenure is one experience factor, with more
mobile, short-tenured senior executives more likely to engage in illegal activities (Clinard,
1983). Daboub et al. (1995), however, argued that long-tenured executives may become stale
in the saddle (Miller, 1991: 34) and, although less likely to actively participate in fraud because
of their resistance to change, might also become more likely to passively acquiesce to fraud.
Functional background is another experience-related factor that may contribute to fraud
(Figure 1). Simpson and Koper (1997), for example, found that manufacturing companies
headed by CEOs with finance and administrative backgrounds were more likely to engage in
antitrust violations than CEOs with other backgrounds. Scholars have also suggested that military experience may affect the likelihood of corporate illegalities. For example, Daboub et al.
(1995) observed that the ideals and values associated with military leadership may reduce the
likelihood of active participation in fraud, but that the high value placed on group solidarity in
the military may increase the likelihood of passive acquiescence. Consistent with this latter
explanation, Williams, Barrett, and Brabston (2000) found that prior military service among
members of Fortune 500 companies top management teams (TMTs) strengthens the relationship between firm size and corporate criminal activity. In sum, experience-related factors such
as tenure in the job, functional experience, and military service may influence individuals
decisions to commit fraud when faced with challenging environments.
Education
An individuals educational background also can contribute to the likelihood of fraud, as
indicated in Figure 1. The level of education typically is positively associated with the level of
moral development (Rest & Thoma, 1986). Yet, some believe that business education may
cause a decline in moral development, perhaps because the study of normative expected utility
theory (von Neumann & Morgenstern, 1944) in business programs increases self-interested
behavior (see, e.g., Frank, Gilovich, & Regan, 1993). Consistent with this argument, Kelley
et al. (1990) found that marketing researchers with graduate business degrees provided the
least ethical self-ratings, whereas Williams et al. (2000) found that the relationship between
817
organizational size and corporate criminal activity was strongest when Fortune 500 TMTs had
more graduate business education. Ferraro, Pfeffer, and Sutton (2005) reviewed evidence that
suggests that economics education is related to a number of morally questionable behaviors
such as free riding, defection, and selfishness. Ghoshal (2005) argued that by teaching ideologically inspired amoral theories, business schools have freed their students from any sense
of moral responsibility. Mintzberg (2004) has voiced similar observations. Obviously, these
observations invite debate on what business schools teach their students (Feldman, 2005) and
how these values might influence senior managers tolerance (or commission) of fraud.
Gender
Some research has related gender to the proclivity for illegal activities. Daly (1989), for
example, related gender to different types and levels of white-collar crime. Betz, OConnell,
and Shepard (1989) found male business students to be more willing than their female counterparts to accept unethical behavior in achieving their goals. Whan (2003) recently found
male librarians to be more willing than female ones to behave unethically in response to organizational pressure. Thus, a persons gender might influence the strength of the relationships
among industry or organizational pressures and managerial fraud, although, as Whan (2003)
noted, little theory exists explaining the mechanisms through which this effect takes place.
Self-Control
Hirschi and Gottfredson (1987; see also Gottfredson & Hirschi, 1990) offered self-control
theory to explain both white-collar and common crimes. They argued that crime is associated
with one stable individual traitlow self-controlthat is shared by both white-collar and
common criminals. Individuals with low self-control are apt to be risk takers who, when the
opportunity presents itself, opt for the immediate gratification associated with criminal behavior. Thus, the firm provides a setting within which opportunities for white-collar crimes
abound for top managers who are so inclined. According to this view, the characteristics of the
firm are not major causal factors in managers propensity toward criminal behavior.
Critics counter that senior executives must have a certain level of self-control to have
advanced upward through the organizational hierarchy and suggest that this restriction of
range may limit the usefulness of Hirschi and Gottfredsons theory in explaining top management crime (Reed & Yeager, 1996). The extent of any restriction of range for the self-control
trait among senior managers remains an empirical question. Also, there are certainly at least
some instances in which individuals who have reached the highest levels (e.g., Bill Clinton)
have at times exhibited relatively low self-control.
Consequences of Top Management Fraud

Unlike street crimes, which disproportionately victimize the poor and the marginal, top
management fraud is more pervasive and wide reaching in its impact (Moore & Mills, 1990).
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Management fraud has serious consequences to shareholders, employees, the communities in

which firms work, and society at large (Figure 1). Fraud can also damage managers reputations, end their careers, lead to their firing, and cause their imprisonment. Understandably,
recent revelations of massive and widespread management fraud have stirred a heated debate
about the roles of auditing firms, corporate boards of directors, and regulatory agencies in
uncovering and, more important, preventing such activities.
Effect of Fraud on Shareholders and Debtholders

Shareholders are invariably the first victims of top management fraud. When news of fraud
by a firm becomes public knowledge, it immediately reduces the stock market value of the
companies involved (Davidson & Worrell, 1988). Bondholders and other creditors of the firm
can also end up bearing the negative effects of management fraud. If the companys credit rating is lowered when fraud is revealed, bonds issued by the firm lose value, and the bondholders immediately suffer. In many cases, banks may have lent money against either overvalued
or nonexistent collateral or inflated cash flow projections. Not only does this make recovery of
loans problematic, but indirectly even shareholders of banks may end up paying a price
because of the decline in the share prices of the bank itself, if the amounts involved are
substantial.
Revelations of top management fraud also have shaken the publics faith in the ability of
boards of directors to monitor management and protect shareholders wealth. Through fraudulent accounting practices, WorldCom was able to conceal $3.5 billion in losses from its directors (Thompson, 2003). The use of demographic variables in TMT research is based on the
argument that they are proxies for other underlying managerial traits (Hambrick & Mason,
1984). They have been widely used in research, partly because demographic data are relatively easy to collect. However, organizational demography research has come under increasing criticism lately for inferences based on unmeasured variables (Lawrence, 1997), inability
to suggest actionable prescriptive conclusions (Priem et al., 1999), and relying entirely on
archival data (Pettigrew, 1992). Given the pervasiveness of these factors in the literature, we
address each of these individual-level factors next.
Paradoxically, recent management fraud episodes have led to a reexamination of the relative importance of shareholders to other stakeholders. In some cases, shareholders are now
being given priority over creditors when fines and penalties are paid out. Traditionally, creditors were always paid first. However, with Sarbanes-Oxley, shareholders are considered the
biggest victims and therefore entitled to the relief provided by the penalty. Interestingly, one
of the most far-reaching consequences of management fraud may be increased activism and
vigilance by shareholders and other affected stakeholder groups. For example, reacting to the
portfolio losses of the rank and file, labor unions have brought as much as 40% of shareholder
resolutions during the annual meetings in recent years, and the American Federation of
LaborCongress of Industrial Organizations is pushing for rules that would give small investors even more clout (Weiss, 2002). Fraud by senior executives has angered shareholders who
are increasingly fighting back, proactively seeking reparations for the losses they had endured.
819
Top management fraud has negative consequences on other stakeholders as well. Arthur
Andersons demise was a direct consequence of its implicit complicity in Enrons fraudulent
financial reporting. There have also been instances of accounting firms paying substantial
penalties for their failure to detect fraud during audits (Wells, 2000).
Societal Consequences of Fraud

Although there are no exact estimates of the economic costs of management fraud, the cost
to society is considered staggering. In 2002 alone, an estimated $600 billion, or about $4,500
per employee, was lost . . . as a result of on the-job fraud and abuse (Thomas & Gibson, 2003).
Other estimates range from $200 billion (Touby, 1994) to $600 billion (Schnatterly, 2003). An
analysis of well-known cases like Enron reveals a variety of direct and indirect negative societal consequences such as the loss of several thousand jobs; loss of employees pensions,
which was particularly hard on older employees; and loss of tax revenue to the city of Houston
where the company had its headquarters and was a major employer.
Illegal acts, such as managerial fraud, also depress the moral climate in a society
(Szwajkowski, 1985). Fraud can lead to a general lack of faith in the integrity of senior managers; erosion in confidence in the free market system including its political institutions, processes, and leaders; and a general growth of cynicism in a society (Moore & Mills, 1990). The
most corrosive consequence of an environment in which individuals do not trust the leading
institutions of society such as large corporations is the destruction of social capital. Authors
such as Fukuyama (1995) have argued that the economic success of capitalist societies is
based on the level of trust and resultant cooperative behavior prevailing in those societies.
High-trust societies tend to have lower costs of doing business. The recent wave of corporate
scandals in the United States has led to legislation that imposes significant compliance costs
on corporations. This, in turn, is causing small and medium firms to delist from stock
exchanges. It has also discouraged many private firms from going public. The failure on the
part of accounting firms to detect managerial fraud has also led to less faith in audited financial
statements. Worse still, many believe that the accounting firms compromised their own integrity because of the lure of lucrative consulting contracts from the firms they were auditing. Not
surprisingly, recent occurrences of senior management fraud have caused society to take a
much harder line regarding punishment of white-collar criminals and holding them
responsible for their crimes.
Effect of Fraud on Local Communities

The communities that house companies found guilty of fraud also frequently pay a heavy
price for managements actions, although it is difficult to quantify the exact amount of financial losses. Unemployment; loss of endowments for the arts and schools; depleted stock portfolios; and decreased demand for secondary businesses, such as restaurants and gas stations,
all serve to hurt local communities. Examples of communities that have suffered the devastating effects of top management fraud include Clinton, Mississippi, a small college town that
820
housed the world headquarters of WorldCom, and Houston, Texas, that was home to Enron.
During the heyday of these companies, these cities enjoyed a period of unprecedented boom.
Although Houston, Texas, was big enough to survive the fall of Enron, it was nonetheless hurt
by the Enron implosion. The negative impact of Enrons fraud extends well beyond those who
lost their jobs. Companies adversely affected included hotels, restaurants and catering services, transportation providers, florists, and even the full-time locksmith Enron once
employed. For Clinton, Mississippi, the fall of Worldcom proved to be far more devastating.
Effect of Fraud on Employees

Employees of companies that commit management fraud are often hit the hardest, even
though they are often unaware of their managers illegal activities. Fraud can cause employees
to lose their jobs, their retirement savings (which are often tied up in company stock), and their
reputations. Frequently, the very fact that they worked for a fraudulent company taints their
resume to the point that some employees find it difficult to find alternative employment. One
unexpected consequence of management fraud is that companies are starting to develop inhouse whistle-blowing programs to try and stop fraud. These programs encourage employees
to discretely and anonymously disclose concerns about accounting and operational issues
(Murdock, 2003).
Effect of Fraud on Managers Reputations

Fraud also damages the reputations of the individuals and firms involved. In his analysis of
managerial fraud, Beasley (1996) found that in many cases senior managers have been
indicted, forced to resign, or terminated. Indeed, the past few years have seen a sharp increase
in the number of white-collar criminals facing fines and even jail time.
An Agenda for Future Research on Top Management Fraud

We now have examined key societal-, industry-, and firm-level antecedents to top management fraud; the individual-level factors that affect the propensity toward fraud when pressures
from the antecedents occur; and the consequences of management fraud. Our review has captured much of the current knowledge landscape regarding top management fraud (Figure 1).
In this section, we suggest directions for expanding this knowledge through future research.
Leads From Criminology Research

We anticipate increased interest in the management literature in studying management
fraud, and we believe such interest is warranted. Many directions are possible, however, and
not all may be equally fruitful. One approach would be to follow the leads of major research
streams in criminology. Two recent management papers have done just that, and may offer
guidance for future work. The first is Ashforth and Anands examination of corruption in orga-
821
nizations. They argued from a strong sociological perspective that three factors
institutionalization, rationalization, and socializationcan combine to contribute to the normalization of corruption in an organization (2003: 3). Through socialization, corrupt practices become embedded in organizational routines; through rationalization, corrupt actions
are legitimated through organizational folklore; and through socialization, newcomers learn
to accept corrupt behavior as normal.
Although Ashforth and Anand noted that their model is not intended to remove personal
responsibility from individuals for corrupt actions, they proposed that the intertwined processes of institutionalization, rationalization, and socialization conspire to normalize and perpetuate corrupt practices so that the system trumps the individual (2003: 37), and thus they
concluded that the system must be repaired to prevent organizational corruption. Ashforth and
Anands (2003) work, following the tradition of Sutherlands (1949) differential association
theory, offers a compelling extension to othersprevious assertions that the normative status of
business as usual contributes to criminal behavior in white-collar settings (e.g., Reed &
Yeager, 1996; see also Luo, 2005).
A second representative study, this time at the individual level, is the laboratory experiment
by Schweitzer, Ordez, and Douma (2004). They argue that individuals aspirations, represented by assigned goals, influence their perceptions of the benefits that might be achieved by
intentionally overstating performance. They found that people are more likely to lie (via written overstatements of their performance) if given specific, hard goals rather than do your
best goals and that the likelihood of overstating performance increases as actual performance
approaches, but still falls short of, the goal. Schweitzer et al.s (2004) assumption that people
pursue their perceived self-interests, as determined by individual cost-benefit analyses, follows the classical approach to criminology favored by contemporary economists (e.g.,
Becker, 1964). The task in their study arguably represents a close approximation of the decisions faced previously by senior managers who chose to inflate their firms earnings. At a
broader level, Schweitzer et al.s (2004) work extends the tradition of strain theory (Merton,
1938), that individuals who are unable to achieve their aspirations experience strain and may
seek to relieve the strain by using deviant means to achieve desired ends. But Schweitzer
et al.s (2004) results extend these ideas by suggesting that at times, strain may actually
increase as a goal approaches but remains unattained.
These two studies show management scholars extending theories from criminology to
white-collar crime. There are other examples, such as Cullen, Parboteeah, and Hoegls (2004)
cross-national study of justifications for ethically suspect behaviors (based on anomie theory),
but these remain relatively sparse. One area of considerable debate in the criminology literature that has not been addressed yet by management scholars is Gottfredson and Hirschis
(1990) general theory of crime. They argue that although the firm provides the context for
white-collar criminality, all crime is associated with one stable individual traitlow selfcontrolthat is shared by both white-collar and common criminals. The debate between
advocates of differential association and low self-control theories concerning relative explanatory power remains unresolved in the criminology literature (e.g., Simpson & Piquero,
2002). Pratt and Cullens (2000) recent meta-analysis, however, shows that low self-control is
an important predictor of crime, suggesting that this individual trait may warrant exploration
by management scholars interested in white-collar crime. These two theories fit easily into
822
Trevino and Youngbloods (1990) classification of explanations for unethical behavior within
organizations as bad apple or bad barrel theories. Bad-apple theories attribute wrongdoing to individual factors such as low self-control, whereas bad-barrel theories emphasize the
role of organizational and societal factors (i.e., differential association).
Another potential area for top management fraud study involves the construct of trust.
Shapiro (1990) posited that the common thread underlying white-collar crimes is that they all
are violations of trust; that is, senior executives occupy positions of trust that simultaneously
provide the opportunity for crime. Shapiro further observed that white-collar criminals violate norms of trust, enabling them to rob without violence and burgle without trespass (1990).
Management scholars could bring considerable expertise to bear on the trust-related issues
associated with management fraud.
Some Key Research Questions

Clearly, serious gaps remain in our understanding of management fraud. As we reviewed
the literature, we were surprised by the limited and unsystematic empirical research on this
complex topic and the various variables in Figure 1. Despite the public outrage about the prevalence of fraud, systematic empirical research in this area has been rather limited. Accounting
researchers have increasingly studied financial statement fraud in recent years, and management researchers have examined a wider variety of white-collar crimes, but we are still left
with an abundance of anecdotal and journalistic evidence. As a result, we still do not know
the answers to simple questions such as What motivates certain successful senior managers to
engage in such fraud? We do not know how these managers succeed in co-opting and involving others in their fraudulent schemes. We do not know why many members of the organization who, accidentally or otherwise, uncover fraud fail to report it. What perpetuates such
silence and compliance to corrupt authority? These simple questions deserve careful study to
better understand organizational deviance and its ill effects on employees, companies,
communities, and society at large.
Corporate illegal actions, which have been the subject of analysis, are pervasive and have
corrosive effects on society. We need to better understand how top management fraud fits into
the bigger scheme of corporate illegal actions. Perhaps we can develop a typology of corporate
illegal acts that embodies managerial fraud. The development of such a typology may even
help us to identify some perfectly legal and mostly transparent forms of appropriation of
shareholder wealth by corporate executives in the form of excessive compensation and perquisite consumption. Alternatively, a typology of the motivations for, and consequences of, top
management fraud could be developed, serving to guide future research. Using this typology,
we can then relate it to the industry, firm, and individual variables discussed throughout our
review (Figure 1).
A promising area for future research is to explore the joint effects of the industry, firm, and
individual variables on the extent and severity of top management fraud. We know very little
about the effect of these variables on top management fraud, and the few studies to date have
produced inconclusive results. Examining the interactions of industry, firm, and individual
antecedents of top management fraud could be informative. For example, do industry charac-
823
teristics (e.g., short payback periods) accentuate the effect of top managers self-control,
intensifying their willingness to commit fraud? Do they interact with other aspects of personality (Judge & Bono, 2000)? Do industry characteristics (e.g., hostility) perpetuate dysfunctional organizational cultures that, in turn, encourage or facilitate top management fraud?
How do these cultures develop in the first place? Why do they persist?
Earlier in this article, we referred to the bad-apple theory as an explanation for top managers fraud. Essentially, the theory posits that a few corrupt managers commit these actions.
These corrupt behaviors raise several questions that future researchers need to investigate.
Where do these bad apples come from? Why do organizational systems fail to identify
them? What role does the organizational culture play in nurturing their behaviors? What role
do managerial rewards and incentives play in this context? How can organizations develop
effective systems that inculcate and enforce ethical behaviors among senior executives? We
concede that these issues have been the subject of discussion for decades. Regrettably, despite
decades of discussion and reforms, our efforts are failing to curb top management fraud. Fresh
thinking and new ideas are needed if progress is to be made.
Some have suggested that society bears some responsibility for top management fraud.
They propose that the public expects too much from companies and managers, tolerates unethical behavior, and punishes offenders lightly. Obviously, this is a part of a larger debate on
societal values and how they might influence corporate, managerial, and even individual
behavior. Still, the contribution of the larger society to top managers fraud deserves reflection
and examination. It is easy to see how irrational expectations of investors could pressure
senior executives and their companies to work harder. In an environment where competitors
falsify financial statements, overstate earnings, and mislead shareholders, the pressures to
commit fraud by senior managers can also intensify. Of course, these pressures do not justify
fraud.
Calavita et al. (1997) suggested that the prototypical crime of the current era is collective
embezzlement. Unlike well-documented cases of corporate malfeasance in earlier decades,
modern corporate crimes have little or nothing to do with the production or manufacturing of
goods. Instead, they invariably involve the manipulation of money and information. Collective embezzlement is crime by the corporation against the corporation (Calavita & Pontell,
1990: 322). Although this type of crime is for the personal gain of the top management, it
occurs at the expense of the institution and with the implicit or explicit sanction of its senior
management. Collective embezzlement is thus fundamentally different from earlier types of
white-collar crime described in studies such as Other Peoples Money (Cressey, 1953). Modern finance capitalism spawns vast new opportunities for fraud in which highly placed insiders
steal from their own institutions. These crimes are difficult to detect in the short run, complex
in their design and therefore difficult for even those who are financially sophisticated to fully
comprehend, several orders of magnitude larger than manufacturing sector crimes of earlier
years, and extremely difficult to prosecute and obtain convictions because of the various
means available to top executives to cover their tracks.
In addition to the effect of societal norms and institutional context, we believe greater attention to individual variables is needed. We have identified several key individual moderators
that could influence the propensity to commit top management fraud. Future research would
gain from probing four additional issues.
824
The first is how senior managers frame their fraudulent acts. The way managers go about
framing these actions reflects their deeply held values and the context in which they commit
fraud. The second is executives motivation to commit fraud. As noted earlier, multiple
motives might intertwine, causing senior executives to go astray. How much of this fraud is
motivated by greed or a desire to succeed at any cost? How much of it is driven by selfpreservation? How much of top management fraud is intended to save the firm and its employees? The third variable of interest is the opportunity to commit fraud. We have discussed several conditions that provide opportunities in which fraud could be committed and go unreported. Future researchers would improve our knowledge by identifying industry and
organizational landscapes where fraud might occur. The fourth and final variable is the perceived risk associated with committing fraud. How do managers gauge the possibility of getting caught and the potential penalties for their fraud? Understanding these four variables
could improve our knowledge about the way senior executives perceive opportunities for
fraud, their motivation to proceed and commit fraud, and how they weigh the risks associated
with their actions.
The above observations also highlight the need to examine the intimate links between societal norms, public policy, and top management fraud. Societal norms influence public discourse on the role of the firm, ethical managerial behavior, and the best ways to protect shareholders interests. Recent reforms in corporate governance systems and executive
compensation policies reflect this intricate and complex link. Future researchers would benefit, therefore, from exploring how societal norms might influence governance and compensation decisions and, in turn, fraud by senior managers.
Conclusion
Top management fraud is a topic that has stirred passion, concern, debate, and controversy.
This fraud has devastating consequences for shareholders, employees, communities, companies, and society at large. Our discussion of the effects of top management fraud serves as a
reminder of the critical importance of ethical and responsible senior leadership. Boards of
directors must make the recruitment, retention, nurturing, and promotion of such executives a
priority. Organizations must also strive to develop organizational cultures that encourage revelations of abuses and fraud and protect whistle-blowers when they come forward with their
findings (Ashforth & Anand, 2003; McKendall & Wagner, 1997). Such cultures would also
emphasize ethical behavior in hiring, evaluating, rewarding, and promoting employees and
managers alike, while setting and reinforcing realistic performance expectations at every
managerial level. Clearly, human resource management systems have important roles to play
in identifying potential offenders and creating countervailing mechanisms that discourage
fraud (Schnatterly, 2003).
Our review reveals the complexity of the societal-, industry, company, and individualrelated factors that lead to, facilitate, or accentuate fraud. The multiplicity of these variables
and paucity of empirical research that has been conducted on them invite thoughtful analyses.
We hope that our review stimulates systematic and insightful scholarly research into this
important and controversial topic. Where top management fraud exists, we all lose.
825
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Biographical Notes
Shaker A. Zahra is Robert Buuck Chair of Entrepreneurship and professor in the Strategy and Organization Department at the Carlson School of Management, University of Minnesota. His research centers on the intersection of corporate, technological, and international entrepreneurship. The recipient of several awards and grants, his research has
appeared in several leading scholarly journals. He is incoming chair of the Entrepreneurship Division, the Academy of
Management.
Richard L. Priem is the Robert L. and Sally S. Manegold Professor of Management and Strategic Planning at the University of WisconsinMilwaukee. He earned his Ph.D. in strategic management at the University of Texas at
Arlington. He was a Fulbright scholar at the University College of Belize and has visited at the Hong Kong Polytechnic
University, Hong Kong University of Science and Technology, and Groupe ESCEM in Tours, France. His research
interests include top management decision making and processes.
Abdul A. Rasheed received his Ph.D. from the University of Pittsburgh. His research interests include environmental
analysis, corporate governance, international comparisons in strategy, outsourcing, and franchising. He has published
in many leading journals such as Academy of Management Review, Strategic Management Journal, the Journal of
Management Studies, the Journal of Management, Management International Review, International Business
Review, and Strategic Organization. He teaches in the areas of strategic management and international business. He
has lectured at universities in Singapore, Hong Kong, China, and Korea.

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Journal of Management / December 2005

The Antecedents and Consequences