Journal Article Summaries

Journal of Business and Behavioral Sciences

Vol 28, No 2; Fall 2016

104

CORPORATE FRAUD AND EMPLOYEE THEFT:

IMPACTS AND COSTS ON BUSINESS

Stephanie Peters

Balasundram Maniam

Sam Houston State University

ABSTRACT: Corporate fraud and employee theft can affect almost any type of business in today’s business environment. There are many different forms of fraud

and theft that can impact the business results and reputation. Business culture,

ethical strategies, and business activities can all have direct relations to how an

employee or a group of employees have the opportunity of creating scenarios that

result in negative business impacts. Impact costs to the organization can be both

direct and indirect costs to the business, its employees, and its shareholders. This

research also looks at ways that businesses can improve their structure, strategies,

and policies to reduce these fraudulent and theft incidents.

Keywords: Fraud, employee theft, segregation of duties, internal controls,

prevention, culture, impact costs, ethics, ethical behavior.

INTRODUCTION

Unfortunately, corporate fraud and employee theft within businesses today

are not uncommon circumstances. These activities can create far reaching impacts

and effects on the business and have substantial impacts on the cost performance

metrics of the business and the overall morale of the employee workforce. These

affected businesses can carry the weight of the “bad decisions” and unethical

practices of a few associates for many years. A person can barely go a day without

hearing or reading a news article that describes some type of activity that occurred

by a business or its associate that questions one’s ethical behavior practices. There

are varying statistics of the costs that business bear due to employee theft and

fraud, but in 2014, the amount ranged from $20 to $50 billion dollars (Foley,

2014). The cost, however, goes well beyond the total dollar value of the fraud or

theft activity. The impact is also felt on overall company morale, especially the

team morale of the involved associate. Activities such as these also cause other

business and suppliers to question the practices of the “injured” company as well.

Questions are raised about the ethical behaviors of the business as a whole. Only

time and consistent performance and results can improve and remove the tarnish

from the reputation of the affected company or business.

There are many types of corporate and employee fraud that affect business

of all sizes and all types. The fraud and theft can come in many forms – actual theft

of cash, property, or other assets; procurement or contractual fraud; payroll theft;

and misrepresentations of financial statements are just a few. No business is one

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hundred percent immune to having a circumstance occur in their business. Even

businesses that have the most “impactful” and detailed ethics statements and

detailed procedures and segregations can still be a victim. Companies send

employees through training sessions that discuss ethical decision making and

practices that employees should not engage in while conducting business;

however, these occurrences still happen.

A business must ensure that it has practices in place that can help prevent,

or at the least, identify the issue very quickly to prevent larger impact to the

organization. Segregation of duties where there are financial transactions and audit

checks to verify processes are just a few ways that an organization can help to

prevent fraud and theft. Also, simple employee behaviors and actions can also be

indicators of concern – living well above their means and wanting access to

management systems or details that do not relate directly to their role are a few

examples. The instances that allow a person to consider and actually participate in

fraudulent and theft practices are sometimes so innocent in the beginning. This

requires that employers and businesses keep a watchful eye on areas where there

is opportunity for one to be involved in such activity. This report will provide more

examples of fraud and employee theft activities within the business world over the

last several years and will look into the business culture and structure that allows

for the employee behaviors. The paper will provide the impact costs to business –

both direct and indirect costs. The paper will also provide actions or changes that

a business can take to prevent fraud and employee theft.

LITERATURE REVIEW

Corporate fraud and employee theft are not new to this day and age. However, the rates seem to have become more staggering over the last several

years. Back in 2007, it was estimated that theft and fraud by a business’s own

employees cost businesses $100 billion dollars worldwide each year (Sauser,

2007). Another article shows that in 2010 the magnitude of fraud and theft on

businesses worldwide could be as large as $2.9 trillion dollars (Davis, 2013). In

2013, the number of cases of employee fraud and theft that exceeded $100,000 for

each case grew at a record pace of almost five percent (2013: Highest Rate). In

five years of case studies from the Marquet Report on Embezzlement, there were

more than 2100 cases of employee theft that exceeded $100,000 and nearly two

thirds of perpetrators were women (Powell, 2014). These numbers are all

staggering no matter how one looks at them. From the research conducted by Free,

employee misconduct behavior had begun with small incidents and then gets larger

as the associate realizes no one is aware of the issues (2015). Activities generally

do start out very small and almost somewhat innocent like; then, as the individual,

or individuals in many cases, raises their confidence level, the activities become

larger and wider spread across the organization.

Johnson describes the far-reaching impacts of corporate fraud on a

business in terms of “reputational sanction”; in other terms, customers being weary

of dealing with a firm that has dishonest management, which causes reduction in

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demand for their services or products (2014). Also mentioned in this research is

the results that in the fraud cases studied, nearly six percent of customers stop

doing business with a company that has been affected by a fraud event. The

research from Marcel shows that not only are customer relationships affected by

fraud and theft but that employee and board of director relationships are also

affected. In the article written by Marcel, it states that board of directors who

separate themselves from the affected business, normally come out ahead in terms

of reputation (2014, p. 929). By vacating their board post early, it is possible that

their name will not be mentioned in news and press release articles.

Another impact of fraudulent and theft activities is increased government

regulation and policies to address or help to alleviate concerns from the business

world, investment markets and consumers around the world. Such a regulation

would be the Sarbanes – Oxley Act approved in 2002 (also known as the Public

Company Accounting Reform and Investor Protection act of 2002). This act’s

purpose is to focus on internal controls, accounting reports, auditing processes and

review and structure of boards and committees (Milliar, 2009). This Act was a

response to one of the most notorious cases of corporate fraud, Enron. In a study

of the cases of fraud by the Securities and Exchange Commission (SEC) between

1998 and 2007 found that ninety eight percent of cases had involvement of the

CEO or CFO, according to Venkatesan (2015).

Businesses must take actions and implement control procedures with

departments and policies that will help prevent fraud and theft attempts by

associates. The first step is strategic to business function – simply care about your

associates and the work they are performing (Timofeyev, 2014). Internal controls

and segregation of duties are always considered top methods of preventing and

eliminating the opportunities for associates to create fraudulent details or commit

an act of theft against the company. However, it is not as simple as putting controls

and policies in place, a company must “reinforcing and vigilantly adhering to the

existing controls” (Cheney, 2008, p. 20). In looking at various instances of fraud

and theft activities found in businesses today, each business affected must be able

to develop practices that will prevent a reoccurrence.

FRAUDUENT & EMPLOYEE THEFT ACTIVITIES FOUND IN

UNITED STATES BUSINESS

Business examples of fraud and employee theft can come from a business

that is large or small, public or private, and in any shape or form. According to

Curtis Verschoor, a simple search of database in the month of August 2014,

uncovered 200 stories of some type of business related fraud, theft or

embezzlement activity (2014). As shown in other research as well, small to

midsize companies actually have the greatest risk of having a fraud or theft issue

within the business. These instances are also easier for the local new sources to

bring details quickly to the public.

Bernie Madoff’s Ponzi scheme is a well know example of securities fraud

over the last few decades that affected a great deal of people and their personal

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retirement future. This is a situation that had far reaching impacts than just

another’s retirement account. Individuals took their own lives based upon

Madoff’s scheme that affected their whole life’s plan. Another example of

securities fraud would be “pump and dump scheme” in which a party pumps up

the hype about a particular business to get investors to put their money into the

business to raise the market prices, and then when the price reaches the point that

the fraudulent party desires, they dump the stock for a profit for themselves and

causes a loss for the other investors (Galletta, 2015, p. 55).

An example of accounting fraud would be Health South inflated earnings

in the early 2000’s to exceed Wall Street expectations of the business and create

inflated market prices for the business. This inflation of the books was the result

of the CEO’s instructions to the accounting and finance team. Another example

would be the Enron debacle from the early 2000’s as well, that caused both

substantial business investment tidal waves and large losses to the employees of

their business through their life savings. These type of fraudulent activities often

involve the CEO or CFO position of the business. In 347 cases of fraud, 89% of

the cases reviewed by the “Fraudulent Financial Reporting: 1998-2007” involved

the CEO and CFO of the corporation; CEO are implicated in over 72% of the cases,

and CFO are implicated is over 65% (Boyle, 2012).

Employee theft can occur in many shapes, forms, and at any level of

associate within the business. Seventy five percent of employees have taken items

from employers according to the survey conducted by the Association of Certified

Fraud Examiners (Galletta, 2015). This can be an associate that regularly takes

advantage of entering excess hours on their payroll documentation than what was

physically worked; or an associate that takes merchandise from the business

without paying or being approved to take the items and benefits from this in a

positive manner; or could be an instance where the employee is taking funds from

accounts without anyone’s knowledge and depositing them into their personal

accounts. Employee theft could also be an associate that is stealing research ideas

and products from the company and selling them to the competition. In naming

off these few examples of practices that could be considered employee theft, it

helps to document the problems encountered when trying to determine an

estimated amount or value and the scale of employee theft from a business (Sauser,

2007). It is very difficult to put a single amount to what these type of activities cost

the business world each year.

Other types of fraud and theft that impacts business of today are ones that

do not even initially start because of the business or its employees. Corporate

identity theft and database breaches are also large scale issues that affecting

businesses today in terms of their business results and reputations. A recent

example of this would the Target database breach that affected millions of credit

cardholders that had shopped at Target. This type of activity is yet another focus

area for businesses to ensure they have the correct internal controls and processes

in place to protect not just their business data but also the data of the customers

that have expectations of the company to protect them as well. In addition to

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employee behaviors, business culture and practices that are allowed impact what

an employee is capable of committing in terms of fraud and theft.

BUSINESS CULTURE ASPECTS THAT ALLOW FOR FRAUD &

THEFT ACTIVITIES

In many cases of fraud and theft, “the ends justifies the means” to the

associates that end up caught up in the tangles of deceit (Campbell, 2014, p. 301).

An employee or group of employees will rationalize their decision to make

changes to statements, thinking that it does not affect anyone else outside of their

business, when in fact it has far reaching negative effects on many. In Campbell’s

study, because the organizations connect the employee’s success to the metrics of

the business, therefore making it a “win-win situation”, corrupt business practices

can occur without someone raising the awareness flag. Employees that start

committing theft or fraud against a company have the following components:

financial need, opportunity, and rationalization (Rood, 2014).

The business overtone that is set by the CEO is one that will drive its way

through an organization. Research shows that a “suspect” CEO arrival into an

organization can completely drive existing culture out; this comes about through

replacement of key employees with ones that agree with CEO’s focus and

requirements and one that is more than willing to follow the directions provided

(Biggerstaff, 2015). When comparing the cases of fraud and employee theft, there

are commonalities amongst the cases – inadequate controls, no segregation of

duties, follow up and auditing, and poorly completely background checks on

employees (Verschoor, 2014).

Another aspect that comes into the business or employee culture that

brings about theft and fraud is what defines “theft”. This is a question that when

asked of associates the answers vary. Some feel it is not theft if they take time paid

for lunch break where they were not working, others feel like it is not stealing if

items are taken home that have been purchased by the company. These are all part

of business theft, in much smaller scale than the cases that are being discussed in

this research but it is what begins the definition of theft and fraud. An

employee may have issues at home that start the process of trying to figure out how

to survive; the solution may sometimes include utilizing business funds or payment

methods. These situations are ones that employees must be aware of and must

consider in terms of whether or not an employee would have a need or desire to

“steal” from the company.

From Murphy’s research on the prevention of fraud comes the

psychological pathways to fraud diagram shown below. This all starts with an

associate that is not predisposed to fraud activities and has not knowingly

committed fraud (2011). This diagraph walks through the thought process an

associate would go through when considering an activity out of their normal

behavior zone. Along this diagram, there are many points where an organization

or business can provide training, policies, procedures and reminders that would

make an associate chose the path away from the fraudulent or theft behavior

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choice. When an employee gets to the point in the diagram that they rationalize the

fraud, and determination is that it is okay, the employee continues to commit the

fraudulent act at a much larger scale than first intended.

Note: Diagram source - “Psychological Pathways to Fraud: Understanding and

Preventing Fraud” in Organizations in Journal of Business Ethics, 2011.

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Employees feeling like they are not being rewarded properly for the work

that they provide a business is sometimes the starting point for behavior that leads

into a theft or fraud situation. According to Hrncir and Metts, these employees may

have a feeling the business owes them when fraud or theft is being contemplated;

this feeling sometimes starts because of lack of compensation (2012, p. 64). The

chart (table 1) below from Hrncir and Metts’ article shows some red flags from

researched theft cases that businesses can look for within their employee

workforce. From this chart, it is seen that living above one’s means is a top warning

sign, along with employee financial difficulties. When reading various case

studies, these two areas appear to be at the top of many research listings for reasons

an employee would venture into a theft or fraudulent activity. Many times these

acts will start out innocently with a small dollar amount; then, as the employee

realizes it is being successful, the scale goes larger and sometimes for years before

it is uncovered.

Note: Table was retrieved from the article “Why Small Businesses Fall Victim

to Fraud: Size and Trust Issues” by Hrncir and Metts in 2012 from the

Business Studies Journal.

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IMPACTS AND COSTS ASSOCIATED WITH FRAUDUENT &

THEFT PRACTICES

Business loss of sales is a direct cost impact from fraudulent and employee

theft incidents far outweigh the government fines or class action lawsuits that can

be filed against them (Johnson, 2014). With the reduction in production due to

lost sales, the business also faces an increase in the SG&A costs associated with

producing their products. Another direct cost to business in terms of fraud and

theft would be the marketing and promotion costs associated with trying to

improve the business image after such an event occurs. The statistics below come

from the Association of Certified Fraud Examiners research dated 2015. The

median case incident is $175,000 impact to business impacted by fraud or theft.

And over 33% of bankruptcies are caused by employee theft according to the

statistics provided in this review (Association, 2015).

Employee Theft Statistics Data

Amount stolen annually from US businesses by employees

$50,000,000.0

0

Percent of annual revenues lost to theft or fraud 7%

Percent of employees who have stolen at least once from their

employer 75%

Percent of employees who have stolen at least twice from their

employer 37.50%

Percent of all business bankruptcies caused by employee theft 33%

Amount Stolen Percent

$1,000,000 and up 25.30%

$500,000 to $999,999 9.60%

$100,000 to $499,999 28.20%

$10,000 to $99,999 16.80%

$1,000 to $9,999 7%

$1,000 or less 19%

Median Amount Stolen $175,000

Note: Table above was adapted from the article and survey from the Association

of Certified Fraud Examiners in 2015 for Employee Theft Statistics.

http://www.statisticbrain.com/employee-theft-statistics/

The environment or culture is important, not only for success business

results, but it is also important in terms of preventing fraud and theft from

occurring each and every day. The negative effects of a tarnished reputation will

not be felt immediately by companies that have been a victim of employee theft or

fraud. (Guiso, 2015). But over time and additional focus on the situation,

companies do not want to be associated with other companies that have blemishes

on their record for fraud and employee theft, as these areas can be the starting

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points of other unethical practices that management has allowed or turned their

heads too.

From Timofeyev’s study, the charts below show the median loss from

fraud of $200,000 in 2014 and theft that and the frequency rate rose to 36.8 percent

reported in the Certified Fraud Examiners study (2015). This data shows the losses

related to incidents are actually dropping; however, the number of cases per year

are rising by approximately 3% each year.

Business must be willing to make changes within their environments,

practices, policies and procedures in order to be able to prevent fraud and theft

activities from impact the business. The amount of change required or needed to

improve the culture and environment that allows for employees to create a situation

where fraud and theft can occur can vary greatly between the affected businesses.

Note: Figure 1 and 2 were retrieved from the article “Analysis of Predictors of

Organizational Losses Due to Occupational Corruption” by Timofeyev in 2015

in the International Business Review.

.

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CHANGES TO OCCUR WITHIN BUSINESS TO PREVENT FRAUD

AND THEFT

Incidents of fraud and theft within an organization or business can be reduced and prevented with multiple aspects of control. Team awareness,

management support, and cross functional team audits are just a few ways that

could impact the business in a positive way in terms of fraud and theft. In the article

written by Boyle (2012), a business must set a strong ethical tone from the top

leaders of the business to set the culture of theft and fraud being an unacceptable

practice (p. 65).

One way to prevent these activities from occurring is to provide the

leadership structure that makes another employee feel safe to be able to share

concerns and knowledge concerning another associate’s unethical behaviors.

Together, the leadership and the personal safety aspect give the associate the

feeling that the business will accept the information being shared and protect the

source of the knowledge within the process of investigation. (Liu, 2015, p. 115).

The fear of retaliation is most likely reason some will not come forward with

details about other associates. This fear comes about through thoughts of losing a

job or creating a hostile work environment with other team mates. Also, when it

comes to the discussion on whistleblowing on teammates, some associates feel it

is someone else’s place to step up to share the information so they remain quiet

(Fredin, 2012). The work environment must be one that is positive enough to bring

about a more supportive and encouraging environment that also would not allow

for the unethical practices to continue to a point to where it would hurt the morale

and success of the business. And it must be one that encourages team members to

share concerns.

Internal auditors are “eyes and ears of management” and also should have

a high level of professionalism based upon their professional standards (Xu, 2008).

These individuals are definitely in the middle ground between management

behavior that drives the environment of the business and then also the ethical

standards that have been established for one in their profession. An auditor must

be open minded and look at every detail and process with care to ensure that a

business does not have substantial risk in a process or reporting mechanism. A

company does not have to have an “auditor” role to get the benefit that an internal

look at processes and employee behaviors. An associate with an eye for details can

be trained to review another department’s process to verify that the controls and

policies are enforced within the department. Through this process, findings can be

reviewed for improvement opportunities to reduce the possibility of theft or

employee fraud.

Other ways that a business can reduce the opportunity an employee to

create a situation of fraud or theft include:

 Background checks on new hires and current employees if they are handling large funds

Separation of duties for financial department position. Independent

outside review of financial statements to ensure validity

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 Protecting documentation that contains sensitive information or details that could be used in fraud or theft situation

 Audits of departments where there are potential risks – Human Resources and Payroll, Purchasing, and Credit

 Pay close attention to employees who have business credit cards and have a process in place

 According to the article “School Your Clients to Stop Theft”, employees that will not take vacations (2007). These are

employees that could be concern to the business if the role is one

where there is financial reporting or payment processing. The

concern would come about because of not wanting another

associate to look into the processes that could covered up.

In the statistics below from the ACFE 2015 study, tips of other employees

is the largest percentage of fraud and theft detection. Referencing back to the

strong leadership culture and environment where employees feel safe to sharing

details and knowledge about another associates’ behavior is valuable to business

owners and leaders when trying to prevent fraud and theft practices. Accidental

discovery and internal audits are the next methods of finding about an employee’s

theft or fraudulent practices, with nearly 38% of the cases being discovered

through these methods.

Reported Fraud Statistics Percent

Tip from employee 26.3%

Accidental discovery 18.8%

Internal audit 18.8%

Internal control 15.4%

External audit 11.8%

Tip from customer 8.8%

Anonymous tip 6.2%

Tip from vendor 5.1%

Notification from law enforcement 1.7%

Note: Table was retrieved from the research information from the

Association of Certified Fraud Examiners in 2015 on Employee Theft

Statistics.

SUMMARY AND CONCLUSION

Employee theft and corporate fraud is costly impact to businesses in today’s world. The managers and financial departments today must be on top of

internal controls, procedures and policies, and employee business practices to

ensure the business is not affected by these types of incidents. According to Ravi

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Venkatesan, strong leadership can dramatically change the atmosphere and

environment that allows for misconduct like fraud and theft to occur; policies,

procedures, practices and audits are all needed as well but the leadership will make

the biggest impact to prevent incidents (2014). With varying degrees of controls,

audit, segregation of duties, and employee background checks to ensure that

associates do not have issues in the past that would be an indicator of such activity

again. There is not one solid method to prevent fraud or employee theft from

occurring with a business today, but managers and leadership teams must have

practices in place that will reduce the opportunity for an employee to choose to

steal from the company and they must be able to reduce the severity of the incident.

Ronald Reagan said many times while he was in office, “Trust but Verify” so that

is always a good adage for businesses to remember.

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