CEOs, CFOs, and Accounting Fraud

Implications of Recent Research

Douglas M. Boyle, CPA, CMA, and Brian W. Carpenter, PhD, and Dana R. Hermanson, PhD

Accounting fraud, or fraudulent financial reporting, has been an ongoing concern for U.S. investors for several decades, with periodic waves of accounting fraud cases leading to substantial investor losses and overall reductions in investor confidence. Research has documented the devastating effects of accounting fraud cases. For example, Jonathan M. Karpoff, D. Scott Lee, and Gerald Martin (“The Cost to Firms of Cooking the Books,” Journal of Financial and Quantitative Analysis, 2008) found that firms committing fraud are severely punished by the market: “For each dollar that a firm misleadingly inflates its market value, on average, it loses this dollar when its misconduct is revealed, plus an additional $3.08.” In addition, a recent Committee of Sponsoring Organizations of the Treadway Commission (COSO)--sponsored study, “Fraudulent Financial Reporting: 1998--2007,” found that fraud firms were much more likely than similar no-fraud firms to declare bankruptcy, be involuntarily delisted, or have material asset sales in the wake of the fraud. Thus, the consequences to investors of accounting fraud often are quite severe.