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Analyses of Corporate Scandals and Fraud in Europe: Environmental

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Analyses of Corporate Scandals and Fraud in Europe: Environmental Analyses of Corporate Scandals and Fraud in Europe: Environmental, Market and Corporate Characteristics ABSTRACT This study analyzes the processes that lead companies to sink into fraud in the European context at the institutional, corporate and firm levels. Using an extended theoretical framework, the study examines the six most significant European financial scandals: BCCI (UK), Gescartera (Spain), Parmalat (Italy), Royal Ahold (Netherlands), Skandia (Sweden) and Vivendi Universal (France). This research supports the shortcomings in the regulations at the European institutional and national levels with respect to business ethics, corporate functioning and governance. It also sheds light on the conditions of the bubble economy and the spirals created by increased pressure from the market during the period preceding the corporate scandals. Beyond the similarities of the major causes of failures in these companies, the analyzes provide insights into unethical behaviour, ineffective boards/governance, dominant CEOs and family shareholders/blockholders, the alignment of incentives of management and major shareholders, accounting irregularities, inefficient internal controls and the failure of auditors. Key words: European Corporate Scandals, Failing Regulations, Bubble Economy, Family Ownership, Ineffective Board/Governance, Management Incentives 1 1. Introduction There has been growing criticism of the functioning of the capital market economy, particularly with regard to management misconduct and unethical corporate behaviour, the lack of high- quality accounting and financial reporting, the inefficient role of intermediary parties (auditors and financial analysts) and ineffective corporate governance and control mechanisms. The numerous cases of corporate deviance and high-profile financial scandals in the last decade in the United States (e.g., Enron, WorldCom, HealthSouth, Adelphai, Delphi and Halliburton) provide some insights into the ‘dark side’ of the capital market economy and show that without resolving several central corporate issues and bottlenecks – some of which are related to the structural nature of the capital market economy – it is highly unlikely that the market can run smoothly in the future. In addition to the ‘big financial scandals’ in the US, Europe has also experienced its share of corporate frauds, and was in the throes of several significant high-profile cases during the same period, caused by management misconduct and wide-ranging corporate deviance. However, for several reasons regarding institutional, cultural and regulatory factors as well as the role of the media, the US cases have been largely publicized. A few of the cases have received particular attention in the academic literature (Enron and WorldCom), especially from the viewpoint of management misconduct and the problems associated with accounting, auditing and corporate governance, despite the fact that the reasons for corporate deviance and financial scandals extend much further than these shortcomings. Glancing at the European environment, there has been very limited media coverage and few research publications in the academic literature, compared with the US context. In this study, 2 we approach corporate fraud issues from a different angle and in a much broader context than accounting, auditing and unethical corporate and managerial topics, which are used in most previous studies conducted in the US. Furthermore, we conduct an in-depth analysis of corporate fraud and financial scandals in the European context at three interrelated levels – institutional and regulatory, financial market and firm – of six major financial scandals and cases of corporate deviance (BCCI, Gescartera, Parmalat, Royal Ahold, Skandia and Vivendi Universal), respectively, in six different marketplaces in Europe (the UK, Spain, Italy, the Netherlands, Sweden and France). In line with the above-defined scope, we set up a theoretical framework including the aforementioned issues in which we then examine three research questions. The first deals with the European environment, in which six selected cases of high-profile financial scandals occurred. This contributes to a better understanding of the catalyzer effect of the environmental factors that may provide favorable conditions for corporate fraud. The second question examines the role of the bubble economy and market pressure, which may affect management behavior in committing fraud. Questions 1 and 2 are interrelated, particularly because the European capital market, similarly to the American context, operates under the law and regulatory frameworks and the key issue is that the market conditions, whether favourable or unfavorable, should affect the policy makers. The third research question attempts to provide insights into the firm-specific characteristics of the six selected high-profile European corporate failures, particularly with respect to the shareholder structure, the alignment between executive compensation packages and shareholders’ interests, an ethical climate and control environment, governance and control mechanisms and the role of external auditors. The present study differs in several respects from the previous papers. First, it concerns corporate fraud in the European environment, which has not, compared with the US context, been 3 sufficiently debated in the academic literature. Second, in contrast to most published papers relevant to American corporate fraud cases, which mainly deal with accounting irregularities, auditing and unethical management behaviour, the current paper examines corporate fraud and financial scandals at a deeper level within the company and the environment in which it operates. Indeed, this research study considers the environmental factors and market conditions that may be determinant in creating a favorable climate for organizations and those who are in command to sink into fraud. The third major contribution is that the paper sheds light on the process of corporate fraud from a board range of multidisciplinary perspectives, including the influence of the shareholder structure (e.g., family ownership and shareholders’ concentration), a poor ethical climate, creative accounting and fraudulent financial reporting, ineffective corporate governance and control mechanisms and market-based management compensation. Rather than looking solely at the causes of corporate failures and scandals, we believe that the research approach of this study, which is based on analyses of the processes that lead companies and managers to sink into fraud, provides better insights into corporate and management fraudulent actions. The paper is organized as follows. After discussing the research motivation and its contributions, we shall begin with an introduction to the theoretical framework for our study. This includes a literature review regarding the main theoretical topics that will be discussed in the paper. The third section presents the research design, the procedure for selecting and analysis of the sample companies and the research questions. Subsequently, we present the results of our analyses by referring to the three research questions. The concluding remarks of the study will be provided in the final section. 4 2. Research Motivation and Contribution The issue of corporate fraud has been extensively analyzed, particularly in the last decade, with an increasing number of high-profile financial failures. However, most previous research papers examine corporate fraud scandals in a general manner and particularly in the US context with respect to accounting irregularities, financial statement fraud, auditors’ failures and management misconduct (e.g. Baker and Hayes 2004; Brody et al. 2003; Craig and Amernic 2004; Cullinan 2004; Ferrel and Ferrell 2011; Hogan et al. 2008; Lee et al. 2008; Morrison 2004; O’Connell 2004; Rezaee 2005; Reinstein and McMillan 2004; Rockness and Rockness 2005; and Unerman and O’Dwyer 2004). Besides the scope limitation of the above research studies and the point that most of them were oriented towards accounting, financial reporting and auditing issues, they were exclusively related to the US financial markets, whereas there has been a significant number of corporate fraud cases in recent years in other parts of the world. In the European context, apart from the case of the UK-based BCCI, which, due to the size and importance of the fraud as well as its political implications, received substantial publicity in the media and was subject to several special reports by political institutions (e.g., UK House of Commons 1991 and 1992a and b; U.S. Senate Committee on Foreign Relations 1992 a and b) and several research studies (e.g., Mitchell et al. 2001; Lee et al. 2008), the other European cases have been examined only in a few research documents (e.g., Soltani and Soltani 2008; Cohen et al. 2011; Soltani 2005, 2013). This paper is particularly interested in the environmental conditions within which corporate frauds and financial scandals occur as well as in a broad range of firm-specific characteristics. The main objective of this paper is to examine corporate scandals and financial fraud within the European context by using a broad theoretical framework and by taking into 5 consideration the factors associated with the European regulatory framework (laws and regulations) and financial market. Although we acknowledge that financial and corporate fraud is, in most cases, intentional, the study aims to provide an insight into the processes that lead publicly
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