Unethical Financial Reporting: An Empirical Analysis of Causes and Consequences

Unethical Financial Reporting: An Empirical Analysis of Causes and Consequences Ajay Kumar Singh and Sakshi Vasudeva Abstract The study attempts to identify the major causes and consequences of unethical financial reporting. We also try to find out if these causes and consequences discriminated between two groups of respondents. The study is based on primary survey with respondents including Chartered Accountants and commerce/ management teachers in Delhi. Using factor analysis and discriminant analysis, we find that ‘delay in final judgement of fraud related court cases’ is the most important cause of unethical financial reporting followed by ‘inadequate punishment for defaulters’. Other important identified causes were protection of self-interest of the auditor and the company, lack of effective corporate governance in the company, and whistle-blowing issues. The identified consequences include law suits against the company as the most important one, followed by increase in the volatility in stock market. The most important factor identified is the decline in the stock market valuation followed by loss of credibility of the company. The results also varied among two groups of respondents for identifying factors of causes and consequences. Keywords: Unethical financial reporting, Corporate governance, Auditor, Credibility, Stock market valuation.

1.0 Introduction Reliable and qualitative financial reporting process is very important for investors. Unethical financial reporting is a menace to society. According to Rezaee (2005), “Financial statement fraud is a deliberate attempt by corporations to deceive or mislead users of published financial statements, especially investors and creditors, by preparing and disseminating materially misstated financial statements” (p.279). _________________________ Dr. Ajay Kumar Singh, Associate Professor, Faculty of Commerce and Business, Delhi School of Economics, University of Delhi. Dr. Sakshi Vasudeva, Assistant Professor, Department of Commerce, Bhim Rao Ambedkar College, University of Delhi.

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2 MUDRA: Journal of Finance and Accounting

Financial reports are prepared by the management and are certified by independent auditors. Management and auditors must act as responsible guardians for the interest of the shareholders. It is the responsibility of both auditors and shareholders to render true and fair view of the financial affairs of the business in the form of financial reports. Hansen et al. (1996) believed that „even auditors are not responsible because management do frauds in such a way that auditors sometimes fail to discover it‟. The reality is that whosoever commits fraud, the actual sufferers are investors. “If accountants and financial analysts, fail to provide investors with reliable information that is relevant to their capital allocation decisions, investors and all the citizens with interest in the success of the economic system, will suffer” (Staubus (2005), cited in: Rhodes, 2010, p.2). There are number of factors which contribute to fraudulent financial reporting. Zahra et al. (2005) found diverse causes of fraud related to society, industry, organization, and individual. Beverley et al. (2007) mentioned various key ethical risks such as protection of self-interest and lack of ethical sensitivity. According to Lee (1995) and Parker (1994), „self-interest has been considered as one of the important cause. Some desire to depict rosy financial picture to conceal material losses to improve their own remuneration or to conceal their own shortcomings.‟ The consequences of financial statement fraud are also diverse like its causes. The collapse of Enron, Satyam, WorldCom and the like has resulted in serious effects like closing of business, law suits against the company, and many more. Some innocent people who invested their hard earned money on the trust of fraudulent financial statements lost their money. Rezaee (2005) advocated, “Perpetrators of financial statement fraud, from top executives to employees, should understand that “cooking the books” is a crime that will be prosecuted.” (p. 292). Others might believe that transition to IFRS would prevent unethical financial reporting because of internationally certified accounting standards and reporting requirement at market/fair values. Zahra et al. (2005) discussed some serious consequences of top management fraud to shareholders, employees, the government, and the society at large. Moral climate of the society gets depressed because of any fraud (Szwajkowski, 1985). There is substantial reduction in the price of stock and value of bonds (Davidson and Worrell, 1988). Similar results were faced by the companies involved in financial fraud such as:

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Unethical Financial Reporting 3

    

Shareholders and debt holders lost their investments. Employees and top executives lost their jobs and suffered criminal and civil litigations resulting in both penalties and imprisonment. Companies got delisted and businesses closed down. It affected even associated businesses such as suppliers. Some innocent employees not only lost their jobs but their pension benefits. There was loss of tax revenue to the government.

2.0 Review of Literature Jones and Kavanagh (1996) mentioned about mentor and peer group influence in unethical financial reporting. A survey was conducted in the US to assess the successfulness of its MBA programmes and questionnaires were sent to the corporate community of Fortune 500 companies as well as business schools. It revealed that out of 12 core areas of management curriculum like accounting, finance, marketing, management, economics, and so on, ethics was the one which was strongly supported by the corporate community (Presidents of Fortune 500 companies) as well as business schools. Importance of high morals was scored at 6.04 on a 7 point scale in a study cited in Singh and Singh (1999). Dietrich et al. (2001) used data on mandatory annual fair value estimates for UK investment property companies and found selling prices more accurate than their corresponding historical costs. McPhail (2003) highlighted the importance of ethics education. Staubus (2005) suggested that ethical failures could not be prevented as long as managers continue to control the „independent‟ auditors and the membership and activities of the board of directors. Rezaee (2005) identified factors using theoretical studies that may increase the likelihood of financial statement fraud. The authors insisted that „understanding of interactive factors (CRIME) would help in both fraud detection and prevention.‟ Zahra et al. (2005) drew on theories from criminology, psychology, sociology, and economics to define the variables contributing to top management fraud and diverse consequences of fraud. The factors and consequences related to


fraud were found to be complex consisting of “societal, industry, company, and individual related.” Beverley et al. (2007) conducted an online survey of members of professional accounting bodies worldwide for identifying ethical issues, causes of ethical failure and the need for ethics education. The important reasons identified were „conflicts of interest, earnings management and whistle-blowing‟. The findings also demonstrated the relevance of dedicated ethics education to members of professional accounting bodies. Singh et al. (1999 and 2000); Singh (2001, 2002 a & b, and 2003); Singh and Rastogi (2001); and Singh and Goel (2001 & 2007) conducted a number of studies on values of professionals. The studies strongly underlined the importance of building up ethical values of professionals. Thomas and Hervé (2008) concluded “the pervasiveness of earnings management did not decline after the introduction of IFRS, and in fact increased in France.” Mary et al. (2008) explored five factors viz; “corporate transparency, the money culture, vices of a capitalistic society and the legalistic culture” responsible for ethical failures. The ethics education was found to have a moderate influence on ethical behaviour of accountants. McManus and Subramaniam (2009) conducted a survey questionnaire that highlighted that “mentoring, peer support, ethics education and personal ethical orientation as vital factors influencing their ethical development and stance at the workplace.” Lather, et al. (2010) explored the issues related to organisational Culture by conducting a study of selected organisations in the manufacturing sector in the NCR. Sinha, et al. (2010) studied the impact of work culture on motivation level of employees in selected public sector companies in India. Brown (2011) believed that „mandatory use of IFRS would improve both transparency and the quality of financial reporting‟. Singh and Sharma (2011a & b) discussed culture of sharing good practices by identifying key attributes of knowledge management through an empirical study in telecommunication and software industries. Singh and Sabharwal (2011) talked about developing talent in people so that they develop ethics by developing Talent Quotient Model for effective talent management through an empirical study.


Singh and Sahi (2012) explored learning styles of people by conducting an empirical analysis of preferred learning mode and instruction approach. Significant relationship was found between active experimentation learning style and preference for facilitator instruction approach. Singh and Vasudeva (2013) found an association between ethical values of accounting professionals and their choices in ethical dilemmas in their profession. Ethical value score of professionals were found to be more explanatory than formal ethical education. The study strongly recommended building up of rigorous ethical and fiduciary responsibility in the financial sector through various means. Singh and Kumar (2013) discussed about transformational leadership by combination of ethics and spirituality. They carried out the construct validation of employee engagement to determine the antecedents of EE in India. They also introduced the spirituality dimension in the construct of EE and thus suggested a novel SAEE scale. The study would assist the managers and top management of the organizations to design a suitable job for every employee. Singh and Kumar (2013) explored the various dimensions of leadership and recommended that non bossy behaviour of leaders is appreciated by people in the organization. 3.0 Importance of the Study As financial fraud has serious consequences for a number of stakeholders; therefore, considerable research has been done in this area. There is reasonable research evidence on the relationship between parameters such as ethics, education, moral values, accounting standards and those relating to financial fraud, lapses on the part of auditors, lack of adequate punishment, delayed punishment, and greed for more money. We have taken 38 statements related to these factors in our study. The outcomes of financial fraud are extremely important in studies as unethical financial fraud affects the society, the government, the investors, the suppliers, and the employees.


4.0 Research Objectives and Methodology 4.1 Objectives of the study The primary objective of this study is to broadly examine the important causes and consequences of financial statement fraud. Therefore, the objectives are as follows:  To identify the important causes resulting in unethical financial reporting.  To identify the important consequences of unethical financial reporting.  To identify the main factors for causes and consequences from a number of related statements.  To examine whether there is any differences in the opinion of commerce/management teachers and chartered accountants for factors related to causes and consequences of unethical financial reporting. Thus, to determine whether these factors of causes and consequences of unethical reporting have discriminated between two groups of respondents. 4.2 Research methodology Nature of the study The study is sample based. The data has been collected with the help of wellstructured questionnaire from the chartered accountants and commerce/ management teachers from Delhi of all age groups. Sample Size The data was collected from 200 respondents out of which there were 84 teachers and 116 Chartered Accountants. Tools and Techniques Factor analysis technique has been used to determine various factors of causes and consequences of unethical financial reporting. Graphical analysis of normality was done using Normal probability plot for the data gathered for causes and consequences. As the Plot depicted normal distribution (diagonal line) for most of the causes and consequences, therefore, t-test being a powerful parametric test was used to know the difference of opinion among teachers and chartered accountants. The distribution was found normal using one sample Kolmogorov-Smirnov Statistic also for causes and consequences.


In order to identify the difference of opinion among the two groups of respondents, discriminant analysis has also been employed to know the significant influence of various factors of causes and consequences of unethical financial reporting. Validity and Reliability The questionnaire used has been verified with the help of content validity (face validity). A pilot survey among a sample of 20 chartered accountants was conducted to examine the reliability and validity of the statements representing causes and consequences of unethical financial reporting. Reliability was tested using Cronbach‟s Alpha for causes and consequences of unethical reporting. Further, Kaiser –Meyer – Olkin value and Bartlett‟s test of Sphericity was also used to verify the applicability of factor analysis.

5.0 Analysis and Interpretation Data analysis to know causes and consequences of unethical financial reporting and to compare it across teachers and chartered accountants has been provided in three stages. In the first stage, we use weighted mean scores; in the second stage, we employ factor analysis and independent t-test; and in the third stage, we use discriminant analysis. 5.1 Comparative analysis of weighted mean scores of teachers and Chartered Accountants Tables 1 and 2 show the weighted mean scores of teachers and Chartered Accountants for various causes of unethical financial reporting. The value 5 was assigned to „Strongly Agree‟ and 1 to „Strongly Disagree‟. The values below 3 signify disagreement and above 3 indicate agreement. Causes of unethical financial reporting The most important identified causes were:  Delay in final judgement of fraud related court cases with mean value 4.58  „To boost share prices‟ with mean value 4.36  „Inadequate punishment for defaulters‟ with mean value 4.35  Lack of balanced corporate system with mean value 4.31  Inefficiency of Internal Audit System with mean value of 4.20  Inadequate and ineffective Internal Control System with mean value of 4.13


    

„To meet up or exceed security analyst‟s earning expectations‟ with mean value of 4.12 „Unethical conduct is embedded in the culture of the society‟ with mean value of 4 Unethical corporate values and behaviour with mean value of 3.98 Non-vigilant audit committees with mean value of 3.96 Whistle blowing issues with mean value of 3.96. Table 1: Causes of unethical financial reporting Causes of Unethical Reporting 1. Vagueness of Accounting Standards. 2. Book value as the method of valuation of assets. 3. Lack of Professional body support. 4. Lack of efficient law and regulation. 5. Inadequate punishment for defaulters. 6. Delay in final judgment of fraud related court cases. 7. Failure to maintain objectivity and independence. 8. Lack of professional competence to judge and deal with cases of violation of GAAP. 9. Inappropriate Professional Judgement.

Teachers (T) 2.56

CAs (C) 2.12

Highest

Results

T

Overall Score 2.31*

2.52

2.09

T

2.28*

Disagreement

2.99

2.79

T

2.87

Disagreement

3.40

3.16

T

3.26

Agreement

4.20

4.47

C

4.35*

Agreement

4.40

4.70

C

4.58*

Agreement

3.33

3.66

C

3.53*

Agreement

3.12

2.84

T

2.96

Agreement by teachers and disagreement by CAs

3.25

2.43

T

2.78


Disagreement

Unethical Financial Reporting 9 10. Lack of ethical sensitivity. 11. Inadequate moral and character development from childhood. 12. Auditors are not trained to realize the implications of unethical reporting during the professional course. 13. Inadequacy of ethics education and directions for accounting education. 14.Client/Management advocacy. 15. Failure to withstand advocacy threats. 16. Lack of support from Organization and the peers. 17. Improper leadership and ILL Culture. 18. Whistle blowing Issues. 19. Conflict of interest between management and owners. 20. Self-review threats.

3.69

3.38

T

3.52*

Agreement

3.57

3.35

T

3.45*

Agreement

2.70

2.32

T

2.48*

Disagreement

3.14

2.52

T

2.78


3.61

3.17

T

3.36*

Agreement

3.81

3.93

C

3.88*

Agreement

3.46

3.59

C

3.54*

Agreement

3.60

4.01

C

3.84*

Agreement

3.87

4.02

C

3.96*

Agreement

3.76

3.78

C

3.77*

Agreement

3.25

2.72

T

2.95


21. To improve their own compensation packages.

3.44

2.76

T

3.05


10 MUDRA: Journal of Finance and Accounting 22. Fear to loose audit assignment. 23. Money Culture. 24. Unethical conduct is embedded in the culture of the Society. 25. Vices of Capitalist System. 26. Unethical corporate values and behaviour. 27. Non-vigilant audit committees. 28. Auditors are not independent.

3.54

3.79

C

3.69*

Agreement

3.93 3.54

3.90 4.33

T C

3.91* 4*

Agreement Agreement

3.13

3.69

C

3.47*

Agreement

3.57

4.28

C

3.98*

Agreement

3.54

4.26

C

3.96*

Agreement

3.27

2.83

T

3.01

29. Inadequate and Ineffective Internal Control System. 30. Inefficiency of Internal Audit System. 31. Lack of balanced corporate system.

3.99

4.24

C

4.14*

Agreement by teachers and disagreement by CAs Agreement

3.89

4.41

C

4.20*

Agreement

4.01

4.51

C

4.31*

Agreement

32. To exaggerate financial performance. 33. To boost share prices. 34. To meet up or exceed security analyst‟s earning expectations. 35. To obtain listing status or to prevent being delisted in national stock exchange. 36. To avoid reporting a pre-tax loss.

4.11

4.01

T

4.10*

Agreement

4.18

4.47

C

4.36*

Agreement

4.01

4.17

C

4.12*

Agreement

3.85

3.82

T

3.84*

Agreement

3.76

3.60

T

3.68*

Agreement

Unethical Financial Reporting 11 37. To cover up assets misappropriated for personal use. 38. To conceal deficiencies in performance.

3.35

2.59

T

2.91

3.57

3.46

T

3.51*

Agreement by teachers and disagreement by CAs Agreement

NOTE: Weighted Average Values with asterisk are significant according to T values. Statements in italics were found to be insignificant according to the results.

Some of the causes were found to be insignificant using overall mean values through t-statistic such as:  Lack of Professional Body Support.  Lack of efficient law and regulation.  Lack of professional competence to judge and deal with cases of violation of GAAP.  Inappropriate Professional Judgement.  Inadequacy of ethics education and directions for accounting education.  Self-review threats.  To improve their own compensation packages.  Auditors are not independent.  To cover up assets misappropriated for personal use. Consequences of unethical financial reporting The most important consequences that were identified were:  Law suits against the company with mean value of 4.20;  „Increases the volatility in the stock market‟ with mean value of 4.19;  Predicament of top executives with criminal fraud with mean value of 4.18;  „Loss of investor‟s confidence‟ and „Loss of market capitalization‟ with mean value of 4.17;  Substantial reduction in the price of stock with mean value of 4.14;  „Adversely affects the integrity, quality, and reliability of published audited financial statements‟ with mean value of 4.12  „Depresses the moral climate in the society‟ and „Promotes the culture of corruption” with mean value of 3.98;


 Loss of tax revenue to the exchequer with mean value of 3.91;  „Loss of several jobs‟ with mean value of 3.87; Using overall means, t statistic was computed and none of the consequences were found to be insignificant. Table 2: Consequences of unethical financial reporting Consequences Reporting

Teachers

CAs

Highest

Overall score

Results

1. Loss of market capitalization.

4.10

4.19

C

4.17*

Agreement

2. Substantial reduction in the price of stock.

4.14

4.12

T

4.14*

Agreement

3. Bankruptcy.

3.70

3.35

T

3.49*

Agreement

4. Bonds issued by the firms loose value.

3.63

3.41

T

3.49*

Agreement

5. Delisting by National Stock Exchange.

3.69

3.12

T

3.35*

Agreement

6. Lawsuits against the company.

4.10

4.26

C

4.20*

Agreement

7. Predicament of top executives with criminal fraud.

4.14

4.21

C

4.18*

Agreement

8. Adversely affects the integrity, quality, and reliability of published audited financial statements.

4.32

3.97

T

4.12*

Agreement

9. Depresses the moral climate in the society.

4.18

3.84

T

3.98*

Agreement

10. Decreased demand for secondary business.

3.67

3.15

T

3.36*

Agreement

11. Loss of several jobs.

3.87

3.85

T

3.87*

Agreement

12. Loss of employees‟ pensions.

3.58

3.82

C

3.72*

Agreement

13. Loss of tax revenue to the exchequer.

3.98

3.86

T

3.91*

Agreement

14. Suppliers lose their business.

3.79

3.15

T

3.42*

Agreement

15. Loss of Investor‟s confidence.

3.80

4.19

C

4.17*

Agreement

of

4.13

3.87

T

3.98*

Agreement

17. Increases the volatility in the stock market.

4.15

4.20

4.19*

Agreement

16. Promotes corruption.

of

the

Unethical

culture


5.2 Factor analysis: Causes of unethical reporting For factor analysis, the principal component analysis method was followed using Varimax rotation. In the initial rotation, 9 factors were extracted with Eigen values above 1.0. However, the face validity of the factors could not be justified. This time, the cut-off point of 0.4 was taken to discard the items having lower correlation. Further, we extracted on the basis of fixed number of factors to bring logic to the analysis. The number of factors to be extracted was fixed at 5 and cut-off point kept at 0.4 (Table 3). The five factor structure explained 68 per cent of the variance. Table 3: Factors for causes of unethical financial reporting Factors

Variables

Factor loadings

Lapses on the part of auditor and professional body

Auditors are not trained to realize the implications of unethical reporting during the professional course. Inappropriate professional judgement.

0.817

Inadequate moral and character development from childhood. Self-review threats.

0.813

Inadequacy of ethics education and directions for accounting education. To cover up assets misappropriated for personal use. Lack of efficient law and regulation.

0.785

Client/management advocacy.

0.734

Lack of professional body support.

0.727

Book value as the method of valuation of assets. To improve their own compensation packages. Auditors are not independent.

0.720

0.814

0.813

0.759 0.755

0.711 0.696

Percentage of variance explained and Cronbach’s alpha 26.204% & 0.946


Protection of vested financial interests and ineffective internal control

Unethical surroundings

Improper detection and inadequate and delayed punishment

Corporate system failures

Failure to maintain objectivity and independence. Lack of ethical sensitivity.

0.689

Lack of professional competence to judge and deal with cases of violation of GAAP. Vagueness of accounting standards.

0.673

Money culture. To boost share prices. To exaggerate financial performance.

0.456 0.890 0.851

To meet up or exceed security analyst‟s earning expectations. Fear to loose audit assignment.

0.843

Inefficiency of internal audit system.

0.579

Inadequate and ineffective internal control system. Vices of capitalist system.

0.562

To conceal deficiencies in performance. Failure to withstand advocacy threats. Unethical conduct is embedded in the culture of the society. Lack of support from organization and peers. Unethical corporate values and behaviour. Whistle blowing issues.

0.801

Unvigilant audit committees.

0.630

Inadequate punishment for defaulters.

0.513

Delay in final judgment of fraud related court cases. Lack of balanced corporate system.

0.490

Conflicts of interest between management and owners. Improper leadership and ill culture.

0.632

0.688

0.490 13.24% & 0.883

0.753

0.919

12.72% & 0.864

0.750 0.687 0.660 0.505 0.706

0.708

0.503

9.06% & 0.650

7.04% & 0.673


Tests employed  Reliability analysis was conducted using Cronbach‟s Alpha for causes of unethical reporting. It came out to be 0.912.  Kaiser–Meyer–Olkin value was found to be 0.777, exceeding the recommended value of 0.6. (Tabachnick and Fidell, 2001), and  Bartlett‟s test of Sphericity (Bartlett, 1954), was also found to be significant and thus supported the factorability of the correlation matrix. 5.3 Factor analysis: Consequences of unethical reporting Reliability analysis was conducted using Cronbach‟s Alpha for consequences of unethical reporting. Initially it was 0.713. The following three items were removed:  Penalties (Sanctioned with fines or jail terms)  There is no effect on the fiscal deficit of the government  Increases the dependability of audit exercise on financial statements As a result, the Cronbach‟s Alpha scale reliability increased to 0.831. Kaiser– Meyer–Olkin value was computed at 0.762, exceeding the recommended value of 0.6. (Tabachnick & Fidell, 2001), and Bartlett‟s test of Sphericity (Bartlett, 1954), reached statistical significance, supporting the factorability of the correlation matrix. In an initial rotation, four factors were extracted with Eigen values above 1.0 and small coefficients below 0.5 were suppressed (Table 4). The four factor structure explained 74 per cent of the variance. 5.4 Causes and consequences of unethical reporting: A comparison between the opinion of teachers and Chartered Accountants H01: There is no significant difference in identifying the factors related to causes of unethical reporting among teachers and Chartered Accountants (Table 5). H02: There is no significant difference in identifying the factors related to consequences of unethical reporting among teachers and chartered accountants (Table 6). The t-test has been employed to statistically analyse whether there is any significant difference in identifying factors related to causes of unethical reporting. The findings revealed that various factors have been found to be insignificant where as some showed significant difference in factors of causes of unethical financial reporting among teachers and chartered accountants. The factors „Lapses on the part


of auditor and professional body‟ and „Improper detection and inadequate and delayed punishment‟ were found to be significant differentiators according to the opinion of teachers and chartered accountants at 1% level of significance. Table 4: Factors for consequences of unethical financial reporting Factor

Statement

Factor loading

Percentage of variance explained and Cronbach’s alpha

Decline in the stock market valuation

Loss of market capitalization.

0.924

20.87% &

Increases the volatility in the stock market.

0.906

0.926

Loss of investor‟s confidence.

0.882

Substantial reduction in the price of stock.

0.809

Suppliers lose their business.

0.881

20.75% &

0.837

0.884

Loss of credibility of company

Promotes unethical practices and distrust and punishments

Financial loss to stakeholders

Decreased business.

demand

for

secondary

Bonds issued by the firms lose value.

0.808

Bankruptcy.

0.729

Delisting by national stock exchange.

0.698

Promotes the culture of corruption.

0.876

Depressing the moral climate in the society.

0.869

Adversely affects the integrity, quality and reliability of published audited financial statements.

0.738

Predicament of top executives with criminal fraud.

0.675

Loss of several jobs.

0.753

13.65% &

Loss of employees‟ pensions.

0.687

0.726

Lawsuits against the company.

0.681

Loss of tax revenue to the exchequer.

0.505

18.86% & 0.836


Table 5: Causes of unethical reporting: t test Factors

Category

No.

Mean

Lapses on the part of auditor and professional body

Teachers Chartered accountants Teachers

84 116

Protection of vested financial interests and ineffective internal control Unethical surroundings

Improper detection and inadequate and delayed punishment Corporate system failures

-0.0253 0.1836

Std. Deviation 0.8191 1.0794

tvalue 17.104

Sig. Level 0.000*

84

0.0698

0.7607

4.791

0.030

Chartered accountants

116

-0.0505

1.14307673

Teachers Chartered accountants

84 116

0.1638 -0.1186

0.8290 1.09570445

9.493

0.002**

Teachers Chartered accountants Teachers

84 116

0.2530 -0.1832

1.2619 0.7074

24.831

0.000*

84

0.2425

0.8863

0.741

0.390

Chartered accountants

116

-0.1756

1.0437

„*‟ Significant at 1% level of significance, „**‟ Significant at 5% level of significance

Teachers believed that the „Lapses on the part of auditor and professional body‟ is more important factor than chartered accountants whereas „Improper detection and inadequate and delayed punishment‟ was found to be more important factor according to the opinion of Chartered Accountants. „Unethical surroundings‟ with significance value (0.002) was found to be significant differentiator at 5% level of significance. Chartered Accountants held it more responsible than teachers (The interpretation based on the reported mean values). The other factors include „Protection of Vested Financial Interests and ineffective Internal Control” with significance value (0.030) and “Corporate System Failures” with significance value (0.390) were found to be insignificant differentiators among teachers and chartered accountants in the present study. Therefore, the Null Hypothesis stood accepted for the above two factors: Null Hypothesis stood rejected for three factors. There is difference in the opinion of teachers and Chartered Accountants for three factors, that is, „Lapses on


the part of auditor and professional body‟, „Improper detection and inadequate and delayed punishment‟, and „Unethical surroundings‟. Table 6: Consequences of unethical reporting: t-test Factors

Category

No.

Mean

Std. Deviation

tvalue

Sig. Level

Decline in the stock market valuation

Teachers

84

0.0033

1.0419

0.411

0.522

Chartered Accountants

116

-0.0240

0.9723

Loss of credibility of company

Teachers

84

-0.0340

0.9134

3.742

0.055


116

0.2465

0.9910

Promotes unethical practices and distrust and punishments

Teachers

84

-0.0169

1.1129

5.914

0.016


116

0.1226

0.8946

Financial loss stakeholders

Teachers

84

0.0901484

1.1350

3.500

0.063


116

0.0652799

0.8890

to

*‟ Significant at 1% level of significance, „**‟ Significant at 5% level of significance

The various factors have been found to be insignificant differentiators in the study. So, the second Null Hypotheses stood confirmed for all the factors related to consequences. The results showed that there was no difference in identifying the consequences of unethical financial reporting among teachers and chartered accountants.

5.5 Discriminant analysis Discriminant Analysis was used to identify the difference of opinion among teachers and chartered accountants for factors related to causes and consequences of unethical financial reporting. The data stood the test of normality and linearity. Therefore, Discriminant Analysis was applied to identify those factors of causes and consequences that best distinguishes the two groups of respondents. This was also done to confirm the results obtained through t-test.


Causes of Unethical Financial Reporting A discriminant analysis was conducted to predict whether significant differences exist among two sets of people for identifying the five factors related to causes of unethical financial reporting. The Eigen value indicates the proportion of variance explained. The result shows small Eigen value i.e., 0.190, which shows that it is not a strong function (as shown in table 7(a)). The result also revealed low canonical correlation i.e., 0.399. The square of the canonical correlation is 0.1592 which means that only 16 % of the variance in the discriminating model between teachers and chartered accountants is due to the difference in five predictor variables related to causes of unethical financial reporting. Thereafter, Wilks‟ Lambda was employed. Wilks‟ Lambda is the ratio of within-groups sums of squares to the total sums of squares. A lambda of 1.00 occurs when observed group means are equal. A small lambda indicates that group means appear to differ. The associated significance value indicates whether the difference is significant. The result indicated Wilks‟ Lambda of 0.841 has a significant value (Sig. = 0.000) (as shown in table 7(b)); thus, the group means appear to differ at significance level.

Function 1

Table 7(a) Eigenvalues Eigenvalue % of Variance Cumulative % Canonical Correlation 0.190a 100.0 100.0 0.399

a. First 1 canonical discriminant functions were used in the analysis.

Test of Function(s) 1

Table 7(b) Wilks' Lambda Wilks' Lambda Chi-square Df 0.841 33.930 5

Sig. 0.000

A closer analysis of the structure matrix (Table 7 (c)) reveals various significant discriminators, i.e., lapses on the part of auditor and professional body (-0.509); improper detection and inadequate & delayed punishment (0.508); corporate system failures (0.486) were found to be significant at 5% significance level. (See Table 7(d)) The original and cross validated classification showed that overall 65 % cases were correctly classified. Thus, it is confirmed that there is difference of


opinion among teachers and chartered accountants in identifying the causes of unethical financial reporting. But results vary from what is obtained through ttest for the factors 3 and 5. Table 7(c): Structure matrix Lapses on the part of auditor and professional body. Improper detection and inadequate & delayed punishment. Corporate system failures. Unethical surroundings. Protection of vested financial interests and ineffective internal control.

Function 1 -0.509 0.508 0.486 0.324 0.137

Table 7(d): Tests of equality of group means Factor 1 Factor 2 Factor 3 Factor 4 Factor 5

Wilks' lambda 0.953 0.996 0.980 0.953 0.957

F 9.723 .705 3.948 9.677 8.858

df1 1 1 1 1 1

df2 198 198 198 198 198

Sig. 0.002 0.402 0.048 0.002 0.003

Consequences of Unethical Financial Reporting A discriminant analysis was conducted to predict whether significant differences exist among two sets of people for identifying the four factors related to consequences of unethical financial reporting. Predictor variables were „Decline in the stock market valuation‟, „Loss of credibility of the company‟, „Promotes unethical practices and distrust and punishments‟ and „Financial Loss to stakeholders‟. The results obtained are given in Tables 8(a)-8(d). The results show a small Eigen value i.e., 0.126, which indicates that it is not a strong function (as shown in table 8(a)). The result also revealed low canonical correlation i.e., 0.355. The square of the canonical correlation is 0.1123 which means that only 11 % of the variance in the discriminating model between teachers and chartered accountants is due to the difference in four predictor variables related to consequences of unethical financial reporting. Wilks‟ Lambda of 0.888 has a significant value (Sig. = 0.000) (as shown in table 8(b)); thus, the group means appear to differ at significance level of 1.


Table 8(a): Eigenvalues Eigenvalue % of Variance Cumulative % Canonical Correlation 0.126a 100.0 100.0 0.335

Function 1

a. First 1 canonical discriminant functions were used in the analysis.

Test of Function(s) 1

Table 8(b): Wilks' Lambda Wilks' Lambda Chi-square 0.888 23.268

df 4

Sig. 0.000

The structure matrix (Table 8(c)) reveals various significant discriminators, i.e., loss of credibility of the company (0.855) was found to be significant at 5% significance level (Table 8(d)). The original and cross validated classification showed that overall 57 % cases were correctly classified. Thus, it is confirmed that there is difference of opinion among teachers and chartered accountants in identifying the consequences of unethical financial reporting regarding one factor. These results are contrary to what is obtained through t-test. The t-test found no significant differentiation regarding consequences of unethical financial reporting. Table 8(c): Structure matrix Loss of credibility of company. Promotes unethical practices and distrust & punishments. Financial loss to stakeholders. Decline in the stock market valuation.

Factor 1 Factor 2 Factor 3 Factor 4

Function 1 0.855 0.411 -0.217 -0.080

Table 8(d): Tests of equality of group means Wilks' Lambda F df1 df2 0.999 0.158 1 198 0.916 18.241 1 198 0.979 4.221 1 198 0.994 1.178 1 198

Sig. 0.691 0.000 0.041 0.279


6.0 Findings of the Study

1.

2.

3.

4.

The important findings of the study are as follows: The top ten causes identified for unethical financial reporting are: ‘delay in final judgement of fraud related court cases with mean value 4.58; „to boost share prices‟ with mean value 4.36; „inadequate punishment for defaulters‟ with mean value 4.35; „lack of balanced corporate system‟ with mean value 4.31; „inefficiency of internal audit system‟ with mean value of 4.20; „inadequate and ineffective internal control system” with mean value of 4.13 followed by „to meet up or exceed security analyst‟s earning expectations‟ with mean value of 4.12; „unethical conduct is embedded in the culture of the society‟ with mean value of 4; „unethical corporate values and behaviour‟ with mean value of 3.98; „non-vigilant audit committees‟ with mean value of 3.96 and „whistle blowing issues‟ with mean value of 3.96. The top ten consequences identified for unethical financial reporting are: “law suits against the company” with mean value of 4.20; „increases the volatility in the stock market‟ with mean value of 4.19; „predicament of top executives with criminal fraud‟ with mean value of 4.18; „loss of investor‟s confidence‟ and „loss of market capitalization‟ with mean value of 4.17 followed by „substantial reduction in the price of stock‟ with mean value of 4.14; „adversely affects the integrity, quality, and reliability of published audited financial statements‟ with mean value of 4.12; „depressing the moral climate in the society‟; „promotes the culture of corruption‟ with mean value of 3.98; „loss of tax revenue to the exchequer‟ with mean value of 3.91 and „loss of several jobs‟ with mean value of 3.87. Using overall means, t-statistic was computed and all the consequences were found to be significant. The factor analysis revealed five factors for causes of unethical financial reporting explaining 68 per cent of the variance. These are: i) lapses on the part of auditor and professional body; ii) protection of vested financial interests and ineffective internal control; iii) unethical surroundings; iv) improper detection and inadequate & delayed punishment; and v) corporate system failures. The factor analysis revealed four factors for consequences of unethical financial reporting explaining 74 per cent of the variance. These are: i)


5.

6.

7.

8.

decline in the stock market valuation; ii) loss of credibility of the company; iii) promotes unethical practices and distrust & punishments; and iv) financial loss to stakeholders. To test the hypotheses, t-tests was employed. The factors “lapses on the part of auditor and professional body” and “improper detection and inadequate & delayed punishment” were found to be significant differentiators according to the opinion of teachers and chartered accountants at 1% level of significance. “Unethical surroundings” with p-value of 0.002 was found to be significant differentiator at 1% level of significance. The other factors “protection of vested financial interests and ineffective internal control” with p-value of 0.030 and “corporate system failures” with significance value of 0.390 were found to be insignificant differentiators among teachers and chartered accountants in the present study. The various factors related to consequences were found to be insignificant differentiators in the study. The results showed that there was no difference in identifying the consequences of unethical financial reporting among teachers and chartered accountants. The use of Discriminant Analysis revealed slightly different results. The closer analysis of the structure matrix revealed various significant discriminators, i.e., lapses on the part of auditor and professional body (-0.509); improper detection and inadequate and delayed punishment (0.508); corporate system failures (0.486) were found to be significant at 5% significance level. Whereas “Unethical Surroundings” which was found to be significant differentiator according to T tests was found insignificant differentiator according to Discriminant Analysis. However, the results stood confirmed for the factors viz; “lapses on the part of auditor and professional body” and “improper detection and inadequate and delayed punishment” as significant differentiator among teachers and chartered accountants. The closer analysis of the structure matrix revealed various significant discriminators related to consequences, i.e., loss of credibility of the company (0.855) at 5% significance level. Thus, it is confirmed that there is difference of opinion among teachers and chartered accountants in identifying the consequences of unethical financial reporting regarding one factor. Results are contrary to what is obtained through T tests. T tests found no significant


differentiation in the opinion among teachers and chartered accountants regarding consequences of unethical financial reporting. 7.0 Conclusions and Recommendations The paper identified important causes and consequences of unethical financial reporting. The results varied among two groups of respondents for some factors for causes and consequences. Teachers felt that self-interests of auditors and their lack of professional conduct fuels up unethical reporting. “Delay in final judgement of fraud related court cases” was found to be the most important cause followed by “inadequate punishment for defaulters.” The other important causes that were identified were the protection of self-interest of the auditor and the company, lack of effective corporate governance in the company, and whistle blowing issues. The factor analysis revealed “lapses on the part of auditor and professional body” as the most important factor. Beverley, et al; (2007) had identified the similar kinds of risks in his study such as self interest, failure to maintain objectivity and independence, improper leadership and poor organisational culture, etc. whereas according to Lee (1995) and Parker (1994) sself-interest was considered as one of the important cause. The results were very similar in the current study also. Therefore, it is expected that the unethical financial reporting can be prevented by making the law more severe and swifter in terms of punishments. British politician William Gladstone quoted that „Justice delayed is justice denied‟. The purpose of justice is lost if it is delayed because there is a period of time when the seeker is helpless waiting for courts to grant him relief but relief comes very late. Moreover, some important evidences can also be manipulated if there is a long period of trial. Some deadlines for timely judgement should be fixed. The intensity of punishments such as cancellation of licences, imprisonment and penalties should be made more severe for defaulters. Some check should be put on self-interests of the Chartered Accountants and vested financial interests of the company. People generally believe that unethical may prove promising, therefore, they indulge in wrong activities. The study strongly recommends that rigorous ethical and fiduciary responsibility should be built up in the overall corporate system. There is definitely an


importance of righteous ethical education also in preventing the nuisance. All religious scriptures propagated the merits of self control, motivation, deliberate intention to prevent unethical conduct. Studies such as McPhail (2003); Mary et al. (2008); Singh and Vasudeva (2013) also emphasised the imparting of ethical education. It can be done by incorporating ethical education at school level and as a part of professional accounting training programmes also. Whistleblowing issues are equally important. The whistle blowers frequently face harassment from the people or the organization whom they expose and sometimes from the advocators of law also. The persons who expose illegal activities, violation of law, and dishonesty, should be provided adequate safeguards. Improper detection and corporate governance issues were also identified as important cause in the current study. Razaee (2005) and Mary et al. (2008) also expressed concerns about corporate governance. The good governance ensures that the company adheres to ethical standards of conduct and protection of interest of all stakeholders. India lacks good governance in spite of having so many legislations. Effective Corporate governance includes the role of independent directors, adequate internal control systems, proper functioning of audit committees, etc. Unethical Surroundings perpetuates unethical, immoral activities. So, the right ethical culture should be gradually built up in the society through various means such as ethical education and strict punishments. The consequences cannot be lessened till we remove the causes. The consequences that were identified were „law suits against the company‟ as the most important one followed by „increases the volatility in the stock market‟. The most important factor that was identified was „decline in the stock market valuation” followed by “loss of credibility of the company”. The frauds always proved disastrous for all concerned; hence it is advisable to have ethical conduct. References Bartlett, M. S. (1954). A note on the multiplying factors for various chi square approximations. Journal of the Royal Statistical Society, 16(Series B), pp. 296 298.


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Unethical Financial Reporting: An Empirical Analysis of Causes and Consequences

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