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CEO's With A Criminal Record Are 400% More Likely To Cook The Books

 July 20, 2012 10:09 AM

(By Rich Bieglmieir) In what iStock dubs the No Duh study, researchers looked into CEOs out of the boardroom behavior to see if lifestyle choices spill into how bad boys and girls run their businesses. Bet you know the answer already, don't you?
 
Executives' "Off-The-Job" Behavior, Corporate Culture, and Financial Reporting Risk examined "examine how and why two aspects of CEO behavior outside the workplace, as measured by prior legal infractions and the ownership of luxury goods, are related to the likelihood of misstated financial statements, including fraud and material reporting errors."
 
The authors use the "executive's prior record of legal infractions, including charges of driving under the influence, other drug related charges, domestic violence, reckless behavior, disturbing the peace, and speeding tickets, as a symptom of a relatively low regard for laws and a lack of self-control."
 
Additionally, the research focuses on CEOs' personal spending habits to see if there is a link between "prior ownership of luxury goods" or "low frugality" and the big boss being loose and easy with the company's cash.
 
Matching 110 fraud firms as identified by SEC Accounting and Auditing Enforcement
Releases (AAERs) and 110 nonfraud firms, the results showed that 20 percent of CEOs of fraud firms had a record at the time of the initiation of the fraud vs. 5 percent of CEOs nonfraud firms.
 
Put more sinisterly or to make a catchy headline, CEOs with a criminal record are 400% more likely to cook the books; although 80% leave the criminal behavior at the door. Big spenders, on the other hand, are no more likely than their frugal peers to take liberties with the numbers, but they are subject to taking bigger risks.
 
Two of the biggest factors that influence poor decision making include incentive and lack of control. When the CEO's compensation includes options based on performance and has unchecked authority, the conditions are ripe for financial fudgery.
 
The study finishes up with a trifecta of caveats, but states "Preliminary results of related pilot studies provide further encouragement that RECORD and OWN capture meaningful differences in executives' regard for laws and frugality, respectively, as posited here. While these pilot studies are too preliminary to be conclusive, they do suggest that the inside trades of executives with prior legal infractions have a larger positive relation to future earnings surprises, consistent with trading on inside information.
 
And companies run by CEOs who own luxury goods are significantly more likely to engage in large acquisitions, to invest less in long-term organic growth, to operate assets in place less efficiently, to generate inferior subsequent accounting and stock return per dollar of corporate investment, and to go bankrupt, suggesting a pattern of low frugality with regard to the management of corporate resources."
 
Unlike the mandatory, regulatory disclaimer regarding past performance not being indicative of future performance, before investing, you might want to consider the CEO's rap sheet and credit card bills prior to parting with your money.

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