CEOs with close ties to top executives more likely to commit fraud

Corporate fraud dominates financial news, yet few studies have looked at whether chief executive officers who appoint their own top lieutenants are more inclined to act illegally, according to University of Michigan (U-M) researchers.

U-M business professor E Han Kim and law school professor Vikramaditya Khanna found that the more top executives the CEO appointed, the higher the probability of fraud. Also, that fraud has a lower likelihood of detection.

"CEOs who commit fraud don't act alone," says Kim, the Everett E Berg Professor of Business Administration at the Ross School. "We wanted to focus on white collar crime and the soft influence CEOs have over their top executives. We found the more closely connected they are, the easier it is to bypass controls."

Kim's estimate found that a firm with all four executives appointed by the CEO during his or her tenure has about a 35 per cent higher incidence of fraud and a 20 per cent lower likelihood of detection than a firm with none of the executives appointed by the CEO.

"Committing fraud and keeping it from view requires coordination," Kim says. "When the CEO and the top executives are closely connected, the coordination costs go down. It's also easier to influence others to obfuscate. This is what social scientists call social influence. It relies on norms of liking and social consensus to shape decision making."

Kim, Khanna and their co-authors also found that standard internal and external monitoring systems used by auditors and boards aren't successful at detecting fraud by a connected CEO.