Column: The trouble in catching fraud
Using a sample consisting of firms prosecuted by the US SEC for accounting frauds, Merle Erickson of the Chicago Booth School of Business and his co-authors have examined the mechanisms used by firms to inflate their earnings. They find that reporting fictitious sales is the most common source of income inflation for sample firms. For example, one firm in the sample created a fictitious customer and shipped empty boxes to this customer at the address of a firm employee. Subsequently, the firm sent invoices to this fictitious customer, which made it appear that a sale had taken place, even though nothing had actually been sold. Ultimately, this transaction increases the firm’s financial statement net income, but not its economic income. Firms also understate their costs or overstate their inventory.
Who executes the financial statement fraud? For the majority of the sample firms, the CEO was accused of assisting in the alleged accounting fraud. In about 50% of