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<div class="">July 25, 2013</div>
<h1>Intersection of Fraud and Traffic Violations</h1>
<h6 class="">By
<span>
<a href="http://topics.nytimes.com/top/news/business/columns/floydnorris/" rel="author" title="More Articles by FLOYD NORRIS"><span>FLOYD NORRIS</span></a></span></h6>
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<p>
If the chief executive likes to drive too fast, watch out. He may be more likely to commit fraud. </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
Their results are <a title="The paper (PDF)." href="http://rhdavidson.com/2012/03/31/executives-off-the-job/">reported in a paper</a>,
“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. </p>
<p>
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.
</p>
<p>
That gave them 109 companies where fraud was detected and 109 similar ones where it was not. </p>
<p>
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. </p>
<p>
The criminal records were the most interesting. </p>
<p>
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. </p>
<p>
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.) </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
“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.” </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
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. </p>
<p>
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.
</p>
<p>
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. </p>
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<p>Floyd Norris comments on finance and the economy at <a href="http://nytimes.com/economix">nytimes.com/economix</a>. </p> </div>
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