Motivation and Signals of Financial Reporting Fraud

According to the data from the Treasury Department's Financial Crimes Enforcement Network, over 730,000 counts of suspected financial wrongdoing were recorded in America in 2008, Institutions such as banks, insurers and casinos are required by law to report suspicious activities to federal authorities under 20 categories. Financial institutions filed nearly 13% more reports of fraud compared with 2007, accounting for almost half of the increase in total filings. Every time the exposure of financial reporting fraud heavily reduces investors’ confidence. The authenticity and fairness of financial reports is the key to the effective functioning of security markets. Research of the financial reporting fraud could date from long time ago.

(1) Motivation

The first factor affecting the motivation of fraud is the pressure. When people pursue an interest or are under some kind of pressure, the motivation of fraud will come out. But this interest or pressure must be large enough since people know the cost of being caught of the fraud is quite high. Managers in high levels and ordinary employees have different fraud motivations.

For the management board, they prepare fraudulent financial reporting mainly to reach the intended target. The pressures could be external or internal. External pressures come from the stock market. For example, market’s expectation of the company’s performance, the need to increase the investment will both greatly affect management board’s behavior. Boards of Directors are under pressure from shareholders, so they need to make every effort to increase company’s value. Then the pressure is passed to senior managers, forcing them to achieve the objective, so that the company could show consistent growth and prosperity. The senior managers then pass these pressures to their subordinates through daily management. Therefore, when the performance of the company degrades or the industry is in the downturn, the management board will have the motivation of...