Some of the largest companies in the U.S. are also the most likely to commit financial fraud, according to a recent study led by a WSU professor.
While most people might assume that smaller companies that have fallen on hard times would be the ones to commit fraud in order to survive, that was not the dynamic that researchers found, sociology professor Jennifer Schwartz said.
In fact, what they found was that successful, growing companies were more likely to engage in fraudulent activities, she said.
These Fortune 500 companies did so because they felt they were not growing fast enough, big enough or as much as their competitors, Schwartz said.
“It was these upwardly aspiring firms that were committing the fraud, which was sort of surprising to us,” she said. “We definitely thought it would be [those companies] that were verging on bankruptcy or had their livelihoods at stake. But it wasn’t out of desperation.”
The researchers relied on U.S. Securities and Exchange Commission forensic accountants to find when this misconduct started, Schwartz said. The root of this issue begins at the top. Company leadership and CEOs set growth and sales goals for their teams, but sometimes they do not reach those goals.
When sales goals are not met, companies will use a practice known as “stuffing the channels” to inflate their sales figures, she said. They sell more product, knowing it will be returned or taken off the books, but it temporarily influences their sales, meeting their goals for that month.
Many of these firms start cheating a little bit at a time, thinking they can make up the difference in the future. What might start out relatively small gradually evolves into a bigger discrepancy, Schwartz said.
“So you’re constantly playing this game of catch up, and eventually it does, it catches up with you,” she said. “Over time, when the losses couldn’t be made back up, they kept digging a bigger and bigger hole for themselves and then they had to cover it up.”
Fraudulent activity occurs because of a company’s culture. When companies try to be better than their competition, a competitive culture develops, and cutting corners becomes exciting, Schwartz said.
“In a lot of these companies, it was born out of a desire to win,” she said. “The culture of the company had encouraged sales staff to sell more … but it’s a ruse. It’s not real.”
Financial fraud has far-reaching effects. Not only are investors harmed in this process, but other businesses suffer from their transgressions, she said. Competing companies within the industry make decisions based on false information.
For example, the telecommunications company WorldCom was able to increase its market share through false financials and low prices for consumers. In response, Sprint and AT&T were forced to cut their prices to compete, so they were not making enough profit, according to a research article in the William & Mary Law Review.
Because of this, AT&T cut costs by upwards of $7 billion, laying off 20,000 employees and separating into three units. WorldCom’s fraudulent actions had major consequences not just for individual companies, but for the market and industry as a whole, affecting people on all levels, according to the article.
It was these kinds of incidents that inspired the study Schwartz led. The early financial frauds that took place around the turn of the century, prompted the global financial crisis of 2007. The research team was curious about what the precursors of this fraud were, Schwartz said.
The SEC, which tracks fraudulent activity, has a number of administrative actions it can take to get companies back into compliance, such as civil fines. Ultimately, the agency can assign criminal sanctions, but those actions are pretty rare, Schwartz said.
“There just isn’t a whole lot of accountability,” Schwartz said. “Very few of the individuals who [were] deemed responsible went to jail.”
During the financial crisis, people thought some of the companies that were committing fraud were too large to fail and that penalizing them would be too costly an endeavor for the country, Schwartz said.
The culture and laws in the U.S. are such that those in power make rules to benefit themselves, she said. The interactions between powerful people in corporations and the SEC create a complicated situation.
“It’s a perversity that the individuals who construct these kinds of systems oftentimes escape unscathed,” Schwartz said.
She said these companies value their reputations above all so they can be fast growing and profitable.
“If we could change the culture to encourage these firms to build a reputation based on corporate social responsibility, if responsibility to their workers and to the communities that they’re housed in were a means of gaining prestige,” Schwartz said, “it could be a tool to try to get companies into compliance.”
Ultimately, everyone is a consumer of these companies in one way or another, so no one is left untouched by the actions of these companies, she said.
“We all pay one way or another,” Schwartz said.