CEOs of companies sometimes don’t realize the impact of their actions, on the control environment and fraudulent behavior of people they lead.
The “Fraud Triangle” is used to explain the factors driving fraudulent behaviour and look for red flags in each of these areas. The “points” of the Fraud Triangle are made up of three factors which are generally observed for fraudulent activity to take place:
Pressure: , is the “incentive” for committing the fraud. Such as a financial need.
Opportunity: is created by a weak internal control environment. The person committing the fraud sees an internal control weakness and engages in misappropriation.
Rationalization: is the internal justification by the fraudster. Rationalize like “I am just borrowing this. I will pay it back later.” Or “boss is taking more than I, whereas I am using this money to help my family.”
A recent analysis by Forbes magazine, notes the following four reasons on why CEOs misrepresent earnings;
1️⃣ The “performance based” bonus of CEO which is a larger proportion of the compensation.
2️⃣ CEOs want to ensure they receive a bonus whether the company succeeds or not. The study showed simple methods used, like; continually lowering the performance bar and increasing “cookie jar” reserves to be used for “a rainy day” to beat targets in future years.
3️⃣ A rationalization that “everyone else is doing it.”
4️⃣ They face very little accountability, usually getting to keep bonuses that through legal or regulatory actions are later determined to be unearned.
While CEOs rationalize the occasional misstatements of results for their own benefit, they’re helping to build a culture of small lies or thefts in the organization. Typically, such cons become routine over time, and eventually, the person loses the need for rationalization.
One approach to fighting fraud at an early stage is to target the rationalization element of the fraud triangle. This is by creating a culture of “zero tolerance” for fraud in the organization. The difficulty is that the CEO has to lead by example.