THE NATURE OF MANAGEMENT FRAUD (STUDY OBJECTIVE 3)

Management fraud, conducted by one or more top-level managers within the company, is usually in the form of fraudulent financial reporting. Oftentimes, the chief executive officer (CEO) or chief financial officer (CFO) conducts fraud by misstating the financial statements through elaborate schemes or complex transactions. Managers misstate financial statements in order to receive such indirect benefits as the following:

  1. Increased stock price. Management usually owns stock in the company, and it benefits from increased stock price.
  2. Improved financial statements, which enhance the potential for a merger or initial public offering (IPO), or prevent negative consequences due to noncompliance with debt covenants or decreased bond ratings.
  3. Enhanced chances of promotion, or avoidance of firing or demotion.
  4. Increased incentive-based compensation such as salary, bonus, or stock options.
  5. Delayed cash flow problems or bankruptcy.

Management fraud may involve overstating revenues and assets, understating expenses and liabilities, misapplying accounting principles, or any combination of these. While there are numerous examples of management fraud, two examples follow.

THE REAL WORLD

Enron was forced to restate (reduce) earnings by approximately $600 million because of improper financial reporting. Enron's top management had been hiding debt and losses by using a complex set of special purpose entities (SPEs). These SPEs were partnerships ...

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