When fraud is discovered it is easy to see who perpetrated the fraud. The bigger question is who else is indirectly responsible? What led to the fraud?
Management does not directly tell employees to commit fraud but management can unwittingly create an environment where fraud breeds. Management is responsible for setting the tone for behavior and ethics in an organization and managers are the role models. If these role models fail to show good judgment and ethics then the staff has no direction to follow.
More to the point, ‘A fish rots from the head’ meaning if the culture is broken, only leadership can fix it. If leadership doesn’t establish and protect a healthy culture, some unhealthy culture will fill that vacuum. If the leadership culture itself is unhealthy, there begins the rot, and soon the fish is lost.
Start With The Company Culture
A company’s culture consists of its values, beliefs, and its shared history. The culture influences every aspect of how an organization operates, specifically by describing which employee behaviors management will encourage, versus which behaviors will be actively discouraged or even punished.
One company’s culture is not inherently better or worse than another’s. Each company’s culture is unique, reflecting the organization’s goals and the management team’s attitudes. The key is to have a culture which is driven from the top down.
The Impact of Management
Management should promote a company culture that emphasizes quality work and ethical behavior. However, if managers themselves fail to live up to these standards, it is unlikely that their employees will do so on their own.
The American Institute of Certified Public Accountants publishes a book called The CPA’s Handbook of Fraud and Commercial Crime Prevention to serve as a tool for auditors. The book includes a table highlighting different elements of a company’s culture, highlighting the qualities that increase fraud potential and those that decrease it.
A majority of the elements revolve around management style and practices. The following are some key warning signs that the AICPA says increase fraud potential. Watch out for these in your organization.
Autocratic Management Style
Autocratic managers make decisions on their own, rather than soliciting input from employees. This type of management style can put pressure on employees to perform. Pressure, according to the AICPA, is one of the three main factors that lead to internal fraud.
Autocratic managers devalue employees and can lead to employees rationalizing why committing fraud is acceptable. Employees will begin to justify why they “deserve” goods or monetary rewards and will start committing fraud with a clear conscience.
Centralized Distribution of Authority
Organizations that delegate authority to all levels, rather than keeping it in top management, tend to have a lower potential for fraud. Centralized authority creates many of the same problems as having an autocratic manager. In both scenarios, managers are making decisions with little to no input from their employees.
Note that there is a difference between decentralized authority and decentralized organization. It is possible to have a decentralized company (each business unit operates its own business functions) with centralized authority (central office management team dictates policies and procedures with little consideration from the units) and vice versa.
The reason centralized authority is so dangerous is that, when employees’ opinions and views are not incorporated into management’s decision making process, it is easier for employees to rationalize internal fraud. Rationalization is another of the AICPA’s three conditions necessary for fraud to occur.
The old axiom that you catch more flies with honey than vinegar is also true in business. Employees tend to respond better to feedback that praises positive behavior, rather than criticizes poor performance. According to the AICPA, companies whose managers tend to provide negative, critical feedback experience more fraud than those whose managers provide positive feedback.
Negative feedback can lead employees to feel devalued by their managers, which makes it easier to rationalize stealing from the company. Positive feedback also does not mean showering employees with empty praise, but instead empowering them to do their jobs and acknowledging their hard work.
Managers should also be willing to hear feedback from the other direction. Employees must feel free to raise their hands and point out when a process needs fixing. If information cannot flow both ways, then the probability of fraud increases.
Other Warning Signs
Additional elements of an organization’s culture that point to increased fraud potential, according to The CPA’s Handbook of Fraud and Commercial Crime Prevention, include:
• Focusing on short-term performance measurements, rather than long-term
• Encouraging employees to compete with one another
• Managing from one crisis to the next, instead of guiding the staff towards strategic objectives
• Maintaining rigid, inflexible policies
• Preferring all communication with the staff to be formal and written, as opposed to friendly and informal
Just because an organization’s culture may include one or more of these elements, it does not mean they will experience fraud but it should be lead to an honest evaluation of the culture to look for areas for improvement.
Managers Set the Tone
Managers set the tone and are role models to staff. Establishing an environment of collaboration between management and employees will not only make for a more relaxing work environment, but could also help reduce fraud in an organization.