Conditions Associated with Increased Risk of Fraud A Model for Publicly Traded Restaurant Companies.pdf - 0 views
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Many restaurant industry examples provide evidence that as a firm’s internal control structure weakens and deficiencies are found, the opportunity for fraud increases significantly.
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The main premise of the study tests the application of the fraud triangle framework constructs to publicly traded restaurant companies during the time period of 2002–2014, using proxy variables defined through literature. The proxy variables selected were company size, amount of debt, employee turnover, organizational structure, the Recession, inflation rate, interest rate, executive stock compensation, return on assets, and international sales growth.
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growing pressures from both passive and active investors to constantly increase their stock value in a competitive world where meeting performance goals are necessary to maintain a competitive edge
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To meet targets, it is typical for companies to put additional stresses on their internal control structures by reducing head counts, requiring employees to perform more than one job, and rearranging risk profiles
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The deceptive and corrupt business practicesofthesecompaniesandothersresulted largely from a failure of corporate governance and lack of ethical business practices, in which internal control mechanisms were circumvented by conflicts of interest that enriched executives and damaged shareholders
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Deficiencies are often observed through review of the main business cycles: revenue and receivables, purchasing and payables, treasury and stock, and financial reporting
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Internal controls are often the first avenue of protection in safeguarding assets and thwarting and discovering errors and fraud
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Some research has been conducted in this area, and findings suggest that companies in the telecommunications, technology, financial, and services industries experience the most difficulty with SarbanesOxley compliance efforts because of increased risk of fraud from industry and company risk factors
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Therefore, pressure resulting from expectations of financial performance, opportunity to circumvent internal controls, and rationalization coupled with certain inherent industry factors may contribute to increased risk of fraud
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opportunity to engage in unethical behavior may stem from the macro environment, the operational features, and the specific nature of the business cycles
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Because of this potential for fraud on the company, shareholders, and the public, examining the conditions that may prompt fraud is necessary for the efficiency of the restaurant industry, and namely, for those passive and active investors that are relying on the financial statements to be true and accurate
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the restaurant industry is often susceptible to deficiencies because of its inherent characteristics and high control risk
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Corporate scandals, misappropriation of assets and financial statement misstatement are all very real threats to the restaurant industry.
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the central focus of this study is to understand the factors that contribute to increased risk of fraud to determine why fraud may occur despite the imposed regulation of the Sarbanes-Oxley Act.
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numerous researchers have found indication that executive stock option compensation provides encouragements for behavior that is fraudulent or corrupt
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the study seeks to identify the factors that may provide the optimal criteria to engage in fraudulent or opportunistic behavior, using the incidence of a reported control deficiency as the measurable dependent variable.
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The fraud triangle is the model that explains the factors that may cause an individual or a company to commit occupational fraud.
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The differing classifications and definitions of pressure provide evidence that the construct is not directly observable; therefore, researchers in this field have measured the construct of pressure through proxy variables
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consists of three constructs: pressure/motivation, opportunity, and rationalization. The three constructs offer an explanation as to why management commits fraud, and the dynamic relationship that underlies the acts of occupational fraud.
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pressure may best be classified into four general types that may lead to fraud: financial stability, external pressure, manager’s personal financial situations, and meeting financial targets (
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when considering measurements of external pressures relating to debt financing, the financial leverage ratio is the most common measurement of the amount of debt.
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Both pressures and opportunities are often determined by factors that occur at both the individual and company level (
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ROA, or asset composition, is an appropriate proxy measurement for the pressure of meeting financial targets.
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according to the fraud triangle, it can be said that opportunity does not exist unless a pressure exists.
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nonshareable problems could also motivate groups of individuals, representative of a company’s culture, to commit fraud.
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Opportunity is described as an atmosphere or temporary environment that enables fraud to be committed, usually with a small perceived probability of being caught or reprimanded
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In a study of Swedish restaurant companies, it is noted that competition is very high, often resulting in price wars among different companies that reduce prices and then try to compensate through increased sales
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Some risk factors include the susceptibility of the industry to market changes as well as the nature of the industry, coupled with the specific operations of the company such as whether there are significant or complex international operations; how effective management is at monitoring activities within the organization; and the level of complexity that exists in the organization
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This environment is therefore dependent on the discretionary income of consumers, and this increased pressure may lead to earnings mismanagement through overstatement.
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Public companies in the restaurant industry are susceptible to opportunities for fraud on the basis of the aforementioned opportunities
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The ability to commit fraud in the restaurant industry results from inside knowledge of processes and procedures, and the ability to circumvent controls through weaknesses (
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strong evidence has also linked the CEO position to fraud when the CEO is also the Chairman of the Board. In incidences like this, the CEO is the dominate decision maker for an organization that may provide an increased opportunity for fraud.
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The underlying reason for these three categories of increased opportunities for fraud is the state of the internal controls structure, and management’s commitment to strong corporate governance
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Rationalization is essentially an attitude, belief, or position of the mind or ethical personality that enables an employee or group of employees of a company to intentionally misappropriate assets and then defend their dishonest activities
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Weak corporate governance structures are often presented through ineffective monitoring of management.
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A quantifiable means of capturing this could be through review of executive stock compensation measures.
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excessive use of discretionary accruals may lead to poor audit opinions, providing a rationalized thought for business activities.
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the nature of the restaurant industry is often described as a periodic, seasonal, and cyclic trade
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Defining parameters for financial reporting can also have an effect on reducing the rationalized behavior and the opportunity to commit fraud
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Because these conditions have an obvious effect on earnings and measures of success, this seasonal variability and volatility should be considered when analyzing pressures in the restaurant industry
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For restaurant companies, this means that rationalizations and attitudes can be managed by assessing the internal control environment and understanding the pressures and opportunities that exist for employees.
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Some restaurant industry pressures that may impact profitable sales growth include a lack of understanding of the consumer’s perception, including the relevance of existing brands, and delays in opening new restaurants. Likewise, an inability to consider cost pressures, including increasing fees for supplies, utilities, and health care providers contracted by restaurants, as well as an incapability of obtaining economies of scale in procurement, could compress margins and negatively impact sales and operations profit margin.
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The value in the application of the fraud triangle to the restaurant industry provides an opportunity to extend theoretical contributions that originated from mainstream accounting to hospitality literature, which is severely lacking in the current literature
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Likewise, restaurant companies that are smaller (and therefore may not have strong internal controls) with increasingly complex transactions create additional opportunities for fraud to be committed
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competitiveness is a condition that makes meeting financial targets difficult and provides opportunity for fraudulent behavior. External pressure from analysts and investors may create an incentive to misappropriate assets, which, in turn, distorts common financial measures of success such as return on assets.
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when debt financing exists, in order to address past and future obligations, and remain competitive, restaurant companies are at an increased risk of fraud especially when disruptions in financial and credit markets exist.
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Studies have revealed that restaurant company victory and demise is eventually correlated to restaurant leadership abilities and intentions; therefore, it can be stated that executives and managers’ intentions are of utmost concern in understanding risk of fraud
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firms with increasingly complex operations coupled with changes in organizational structure have less resources to put into internal controls and are therefore at an increased risk for accounting errors.
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.Internationalgrowthissubjecttorisks such as international political and economic conditions, foreign currency fluctuations, and divergent cultures and consumer inclinations
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This study will focus on the variables most pertinent to the restaurant industry on the basis of the inherent characteristics of U.S. publicly traded restaurant companies, as previously described in this section.
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a s a result of workforce diversity and the presence of many perceived low-skilled workers. In addition, as companies within the industry respond to declining performance, publicly traded restaurant companies may be subject to activist investors who wish to see a change in the executive management team. If a shake-up such as this would occur, the organizational structure of the company may become unstable, resulting in much greater opportunities for fraud to occur at all levels.
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this study looks to assess the relation between the amount of debt a company has occurred and the incidence of reported internal control deficiencies.
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Variables relating to rationalization are present in the restaurant industry when considering the motivations and attitudes of management. It is noted that in difficult times, such as the Recession, aggressive financial reporting tactics may be used
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this study seeks to understand the effect of substantial stock compensation on increased fraud risk.
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this study also hypothesizes that poor ROA could increase the risk of fraud, as the pressure provides executive management with the motivation to manipulate earnings.
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this study suggests that the organizational structure of the company may provide opportunity for increased fraud risk through a unitary tone at the top.
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this study analysed the disclosures of publicly traded restaurant companies to determine whether a company has a higher probability of increased fraud risk on the basis of the presented variables.
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The results of the applied probit model reveal for the entire population set of publicly traded restaurant companies that the macroeconomic factors of the Recession, interest rate, inflation rate and unemployment rate all have a significant impact on the increased risk of fraud, as evidenced through a reported internal control deficiency.
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As noted in the overall model, the results reveal that the model as a whole is a significant fit to the data. Although the company-level variables were not significant in the overall model, external factors were each significant.
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Therefore, it can be said that the results of this study empirically support the intuition that changes in macroeconomic conditions may impact increased risk of fraud for companies in the restaurant industry.
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It can be said that there is a significant relation between increased risk of fraud and the macroeconomic factors of interest, inflation, and unemployment rates.
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from a managerial perspective, the study provides evidence that macroeconomic conditions that might affect consumer demand may increase the risk of fraud for publicly traded restaurant companies.
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In addition to the high costs of compliance, it is also important to recognize additional managerial characteristics that may heighten the effects of the macroeconomic conditions on increased fraud risk.
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As indicated by the results of the study, however, many times executive management does not recognize the problems associated with the macroeconomic conditions because of systematic perceptual filters that play the crucial role in the functioning of the company.
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By focusing on the changing macroeconomic conditions that may have an empirical effect on demand, executive leadership will be able to streamline processes to avoid incidences of reporting internal control deficiencies when exposed to the macroeconomic conditions.
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In the restaurant industry in particular, information is also not readily quantifiable, which makes it even more difficult to transform into meaningful and timely information for executive management. Particular examples include consumer insights and how well new promotions are received and moved throughout the market.
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it should be noted that reported internal control deficiencies are indicative of increased fraud risk, but not necessarily conclusive that fraud has occurred. Therefore, just because a company has reported a deficiency, it does not indicate fraud, necessarily.
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According to the model, the managerial factors are only exacerbated by the presence of macroeconomic factors.
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the identified conditions could help managers to improve internal control when a high risk factor is realized. The contribution of this study may allow restaurant companies to deter activities that may result in increased risk of fraud.
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Because the study revealed that the macroeconomic conditions were significant for the entire population of restaurant companies, an area of future research might explore the relevance of the co alignment model (Olsen &R o p e r , 1998) to strategic management decisions to reduce the risk of fraud.
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for purposes of this study, privately traded companies are excluded. This is a limitation of the study because the results may indicate a problem that is more or less pervasive since the sample is representative of a small number of companies in the United States.
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the model is limited in application because it does not take into account fluctuations among the variables over time.
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This article covers the methodology and findings of a study conducted to examine the factors contributing to fraud risk in publicly traded restaurants. The article discusses factors in the fraud triangle, macroeconomic factors, and internal company factors that may contribute to fraud despite protections implemented per Sarbanes-Oxley. The study ultimately finds that internal company factors are insignificant when considering the impact on fraud risk, while macroeconomic factors, such as inflation or unemployment, drastically impact the level of fraud risk that a company may face.
