[Vision2020] Intersection of Fraud and Traffic Violations

Art Deco art.deco.studios at gmail.com
Sat Jul 27 15:27:33 PDT 2013


  [image: The New York Times] <http://www.nytimes.com/>

------------------------------
July 25, 2013
Intersection of Fraud and Traffic Violations By FLOYD
NORRIS<http://topics.nytimes.com/top/news/business/columns/floydnorris/>

If the chief executive likes to drive too fast, watch out. He may be more
likely to commit fraud.

If he lives too high on the hog, worry about whether he is paying enough
attention to work to catch fraud being committed by his subordinates. And
there may be a greater chance that the company is making mistakes in its
accounting, though not fraudulently.

Determining whether fraud was committed at a company is hard enough, but
trying to figure out why is much harder. Presumably some chief executives
do it to get rich from rising stock prices, but others in similar
situations do not give in to such temptations.

Three academics set out to see whether there were any clear differences
between chief executives of companies where fraud was committed and chiefs
of similar companies where fraud did not take place — or at least where it
was never detected. And they found evidence that those who are willing to
violate other rules are also more willing to violate securities laws.

Their results are reported in a
paper<http://rhdavidson.com/2012/03/31/executives-off-the-job/>,
“Executives’ ‘Off-the-Job’ Behavior, Corporate Culture and Financial
Reporting Risk,” which is to appear in the Journal of Financial Economics.
It was written by Robert Davidson, who teaches accounting at Georgetown
University, along with Aiyesha Dey of the University of Minnesota and Abbie
Smith of the University of Chicago.

Examining fraud cases that the Securities and Exchange Commission filed
over the years — covering frauds that began between 1992 and 2004 — the
researchers looked for other companies that were as similar as possible to
the companies that were caught. Those companies were of similar size, had
similar balance sheets and similar prefraud stock market performance as the
fraudulent companies and were in the same industries.

That gave them 109 companies where fraud was detected and 109 similar ones
where it was not.

The academics then hired private investigators to check out the bosses.
They looked for past criminal records, including traffic violations, and
they searched public records to see which cars, homes and boats the chief
executives owned.

The criminal records were the most interesting.

You might think that anyone who rises to the top of a public company would
have a clean criminal record. That does not turn out to be the case.

Of the 109 chief executives of companies found to have committed fraud, 12
had previous encounters with the law that were more serious than a speeding
ticket. The academics counted eight felony drug charges, four cases of
domestic violence and four traffic violations so serious that they were
lumped under the heading of reckless endangerment. (Some of the bosses had
more than one item on their record.)

Of the other 109 — the ones whose companies had not been accused of
committing fraud — there was nothing more serious than an ordinary traffic
violation.

The idea that companies might want to avoid hiring chief executives with a
history of felony drug charges is hardly a surprising one. But it is not as
obvious that even simple traffic tickets seem to correlate with fraud.

Of the 109 chief executives from nonfraudulent companies, just five had
traffic tickets. Sixteen of the fraud company chief executives had such
tickets. Some of them also had more serious violations. Altogether, 22 of
the 109 had some previous violation.

“We still have pretty strong results if we use only speeding tickets,” Mr.
Davidson said. “The implication is you would at least want to consider the
things that are often considered relatively minor.”

The statistics are far from conclusive — 109 is not a large number — but
they may take on a little more weight from the decision of the researchers
to investigate an additional 164 chief executives. They came from 94
companies that were forced to restate their financial statements but were
not accused of fraud by the S.E.C., and from 70 others chosen at random
from the universe of companies that did not have fraud or accounting
errors. None of the 164 had serious offenses, and the proportion with minor
traffic violations was much lower than it was among the fraudulent
companies.

What this could indicate is that people who are willing to violate one set
of social norms are more likely to be willing to violate far more serious
ones.

The identities of the chief executives with records were not disclosed by
the researchers, so we do not know which executive was charged with each
crime, or if he or she was convicted. Given the absolute power some chief
executives have within their companies, it might be interesting to look at
how bosses previously accused of domestic violence treated their
subordinates in the office. The researchers also set out to see if what
they call unfrugal chief executives run companies that are fundamentally
different from those run by bosses who spend less on themselves.

To determine that required decisions on just what constituted unfrugal
behavior. They settled on a definition involving ownership of homes, boats
and cars, which is available from public records. Chief executives were
deemed to be unfrugal if they owned a car that listed for more than
$75,000, a boat that was more than 25 feet long or a house worth more than
twice the average cost of a home near the company’s headquarters.

And what did they find? Unfrugal chief executives are no more likely to
commit fraud than their colleagues, but they are more likely to run
companies where others commit fraud, and they are more likely to run
companies that are forced to restate their financial statements. They are
also more likely to change the pay structure for directors by reducing
stock-based composition. There is some evidence from other studies that
boards with significant equity stakes may be more vigilant in monitoring
management.

Those limits on frugality struck me as perhaps a little low, given the
ample income of many chief executives. Mr. Davidson said they also used an
alternative definition — requiring a $110,000 car, or a 40-foot-long boat
or a home worth five times the area average — and the trends were generally
similar.

I don’t think any of this proves that a traffic ticket should disqualify
someone from running a public company. And it appears that most fraud is
committed by chief executives who have no previous record of criminal
behavior, so that is hardly the only thing a board should monitor.

But the evidence may indicate that boards should routinely run background
checks on top officers and on those being considered for such positions. If
someone does have a bunch of traffic tickets, or worse, that could be an
indication that deeper consideration is needed before that person is given
control of a public company.

Floyd Norris comments on finance and the economy at nytimes.com/economix.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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