The Disposition-Based Fraud Cycle

Introduction

Whereas considerable research on fraudulent financial reporting has been anchored on the fraud triangle, it is now recognized that the triangle’s rationalization condition offers limited insights to our understanding of the financial fraud as a human act (Ramamoorti, 2008). This in turn has spurred interest among researchers to further our knowledge of the human side of fraud. As Cohen et al (2011, p. 287) put it, “The psychological aspects of the individual manager ... play an important role in explaining the fraud.” Raval (2013) proposes an entirely new paradigm, the Disposition-Based Fraud Cycle (hereafter DFC) that in theory, distinguishes between potential actors and non-actors of fraud and explains the cycle of fraud. Chances are, a new way of looking at an exasperating challenge of executive incursions will improve our comprehension of fraud and will offer ways to prevent, not just detect, it.

It would therefore help to review the DFC and examine, in light of current understanding, its potential contribution to new knowledge in the critical domain of executive financial fraud. Additionally, although the model is generally applicable across all levels in organizations, we focus on the highest level of management, for the most reported cases of fraud have a hand of the chief executive (Beasley et al., 2010). Moreover, we take a comparative view of both the groups, actors and non-actors, as we define dispositionally the non-actors as those who have neither committed nor are likely to commit a fraudulent act. A look at both universes at the same time while using the same model should prove enlightening in terms of clear distinctions between the world of doers and non-doers. This in turn, should provide deeper insights into the nature of fraudulent financial reporting (hereafter FFR) acts and perhaps reveal not just pertinent “red” flags, but also “white” flags.

This paper is organized into four main sections. First, we provide an overview of the DFC and benchmark its characteristics and components against what we already know. This exercise will also offer a litmus test of the model’s potential legitimacy as we frame our extant empirical knowledge using the proposed DFC. Simultaneously, such an exercise may raise new questions or contribute additional comfort in the DFC model. Second, we review the case of actors of fraud not in isolation, but rather as an active comparison between those who have, or are likely to, and those who haven’t, or are unlikely to, commit fraud. It is often remarked that not everyone commits fraud, even in light of glaring opportunities and huge incentives or pressures. The question is: where lies the difference? We attempt to systematically propose an answer to this long lasting mystery. Next, we compare the DFC with the fraud triangle to highlight differences and their significance in the identification of fraud risk factors. Finally, we offer additional insights on risk factors that would have greater impact on preventing or detecting FFR and conclude with implications of the DFC and suggestions for further research.