Abstract

In there paper, Pascale Lapointe-Antunes, Denis Cormier and Michel Magnan analyze the governance, control and media patterns underlying financial reporting and asset misappropriation frauds. They argue that the fraud triangle framework (incentive, opportunity, rationalization) that underlies most prevention and detection practices provides a partial picture of the fraud landscape and does not pay enough attention to its dynamic nature. A missing ingredient is managerial hubris, fed by fawning media and analysts, which ignites and accelerates the fraud triangle. Hubris is characterized by exaggerated self-confidence, arrogance and oblivion to reality. Focusing on the population of financial frauds in Canadian publicly-traded firms during the 1995-2005 period, they show that hubris, i.e., irrationality, may be a critical factor to understand corporate financial frauds. In addition, fraud patterns seem to differ significantly between Canada and the United States.

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"(...) Inspired by the CINAR story, our paper addresses two related questions. First, why does such a celebrated business figure as Micheline Charest risk her reputation to engage and pursue fraudulent and/or dubious activities? Second, does directors, auditors and regulators help prevent and/or detect financial reporting fraud when they are dealing with successful and highly reputable individuals such as Micheline Charest? Focusing on a sample of fraud cases pursued by securities regulators, our paper addresses both questions in the following ways.

(...) First, from a conceptual perspective, we revisit the fraud triangle which serves as a basis for most fraud investigations, academic or professional. Beyond incentives, opportunity and rationalization, we argue that managerial hubris ignites and accelerates the propensity of senior executives to commit or be oblivious to fraud. The focus on top management is warranted by the fact that they tend to commit the largest frauds which are most likely to affect the reliability of financial statements (Peltier-Rivest, 2007). Managerial hubris, which reflects one's overconfidence or arrogance, is a concept which is used to describe and explain entrepreneurs' serial failures (Hayward, Shepherd and Griffin, 2006) as well as the overbidding in takeover battles (Hayward and Hambrick, 1997).

Second, from a methodological perspective, we measure managerial hubris by relying on a proxy, favorable media or financial markets' attention (Hayward, Rindova and Pollock, 2004). Prior research shows that hubris can be fed and magnified when there is too much selfreflection of success and achievements.

Finally, from an empirical perspective, we document the market, management, governance, and industry contexts which underlie corporate frauds and assess the interface between fraud triangle dimensions and proxies for managerial hubris.

The evidence that we provide in the paper is consistent with managerial hubris being a key omitted factor in prior research as a determinant of financial frauds. Like moths attracted to the flames that ultimately kill them, managers under the spotlight will gain in self-assurance and a feeling of invincibility, thus leading them to take more risks in their fraudulent activities.

(...) We believe that our study, which Ms. Charest's story embodies, contributes to the current debate regarding auditors' and regulators' responsibilities in the prevention and detection of corporate fraud. Corporate financial reporting scandals such as CINAR in Canada and, on a much larger scale, Enron or Worldcom in the United States, have undermined the public's perception that fraud can be controlled by government-driven governance mechanisms such as mandatory or internal control audits. By putting much emphasis on the role of external auditors in the prevention and detection of management fraud, regulatory interventions have inadvertently exposed what is probably the audit profession "Achilles heel" (Jamal, 2008).

The rest of the paper proceeds as follows. The next section provides a brief overview of the appropriate institutional environment underlying fraud detection as well as prior research on the determinants of financial reporting fraud. The third section develops our conceptual arguments underlying the role of hubris in fraud. The fourth section describes our sample and the methodology used in the paper. Our analysis and findings are then discussed. The last section provides a discussion and a conclusion.

MANAGERIAL
HUBRIS: THE MISSING LINK?

(...) More specifically, we propose that:
Hubris actually ignites and accelerates the sequence of incentives, opportunities and attitudes (rationalization) that bring CEOs to engage into financial reporting frauds or to be oblivious to such frauds being committed in their own immediate entourage (...)

CONCLUSION
The purpose of the paper was to analyze cases of fraudulent financial reporting or disclosure that took place between 1996 and 2005 in Canada. A few key findings emerge. First, similar to prior evidence, many red flags can be identified for all cases. However, in the context of Canada's corporate landscape, such red flags may be identified in scores of other firms that are without any hint of impropriety. Second, to develop a powerful template of factors related with fraudulent activities, we assess case firms' governance quality as well as the extent of market monitoring to which they are subjected. In both instances, we conclude that in almost all cases sample firms had adequate cover for fraud or impropriety as a result of good governance in appearance and extensive stock market scrutiny through the use of prestige investment bankers or analyst coverage. Third, we discover that almost all sample firms and/or their CEO were the objects of positive media or analyst coverage in the period preceding or concurrent to the fraudulent activities. In our view, such coverage translated into a higher sense of self-confidence or invulnerability among the executives, i.e., managerial hubris. Managerial hubris either led guilty executives further down the path of deception and fraud or, alternatively, pulled their supervising executives away from efficient and effective monitoring.

The study provides an extension as well as a powerful contrast to prior U.S.-based evidence. The picture of fraudulent financial reporting and disclosure that emerges is not linear, and is unlikely to be solely driven by red flags which, in any case, would describe a large fraction of Corporate Canada.

More attention needs to be given to signals and indications that create an appearance of good governance but are in reality deception once looked through the prism of senior management's hubris. Indeed, it is highly likely that managerial hubris is present in U.S. cases of fraudulent financial reporting as well:

• The MCI deal...has become the stuff of legend. (Joseph McCafferty, CFO Magazine)
• Scott is being celebrated as one of the country's outstanding CFOs (Cynthia Cooper, 2007, Extraordinary Circumstances, p. 158).

The above quotes refer to Scott Sullivan, former Chief Financial Officer of Worldcom, who is now serving a five-year prison term for his involvement in the massive financial reporting fraud that led to Worldcom's ultimate collapse. The study also brings the pursuit of fraud by managers outside the realm of managerial rationalism that has characterized much prior research on the phenomenon. So far, the economic (e.g., agency theory) or behavioral (e.g., planned behavior) theories that have been used to investigate managerial fraudulent intent and/or actions essentially assume rationality. Inferring that irrationality, as reflected in hubris, may explain corporate frauds is consistent with findings on other managerial actions such as takeover fights.

The study's key limitation is the small sample size (15 firms), which does represent the population of firms sanctioned by the Ontario Securities Commission with a cease-trade order for improper or fraudulent financial reporting or disclosure. However, the small sample does allow for a deeper investigation of the context surrounding each fraud case. Future research may attempt to provide further validation to the emergent model through interviews with concerned individuals as well as with formal quantitative studies through experiments or actual data (expanding from actual fraud to lesser offences)."

NOTE: The authors acknowledge receiving financial support from Autorité des marches financiers, the Chair in Performance Reporting and Disclosure (UQAM), the Lawrence Bloomberg Chair in Accountancy (Concordia) and the CA/Brock University Institute for International Issues in Accounting.

Fait à Québec le 13 juillet 2009.

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