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“Just Say You’re Sorry”: Avoidance and Revenge Behavior in Response to Organizations Apologizing for Fraud

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Abstract

Using two experiments, I examine how apologizing for fraud influences investor's avoidance (selling shares) and revenge (litigation) behavior. Investors in experiment one report how many shares they would sell and how likely they would be to pursue legal punishment after discovering fraud has occurred in an organization they are currently invested in and subsequently reading about management's response to the fraud. I manipulate the nature of fraud as fraudulent financial reporting (misreporting) or asset misappropriation (embezzlement). I also manipulate whether management apologizes, scapegoats responsibility, or remains silent after the fraud. Results show avoidance and revenge behavior is more negative after misreporting fraud. Data suggest that this difference may be partially attributable to the underlying moral norm that is violated. Specifically, misreporting is primarily a moral violation of deception, whereas embezzlement is primarily a moral violation of stealing. Results also show differential investor reactions depending on the type of fraud and management's response. For misreporting, revenge behavior is higher when management apologizes, but there is no effect on avoidance behavior. For embezzlement, avoidance behavior is reduced when the organization apologizes, but revenge behavior is unaffected. In experiment two, I replicate the misreporting condition from experiment one and manipulate apology sincerity. Results show that apology sincerity is positively associated with revenge behavior. Results of these two experiments extend both accounting and trust repair research by emphasizing the importance of disentangling moral integrity-based trust violations and that the adage of "just say you're sorry" is helpful in some situations and harmful in others.

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Notes

  1. I acknowledge that this is a simplistic view of capital markets. As considered by Healy & Palepu (2001) and others, a more full model notes that investors are not entirely trusting, which is why we have intermediaries such as auditors and regulators. However, introducing these concepts does not take away from the fact that some trust level must be established for investors to give their capital to a manager, and when fraud occurs, this trust is broken.

  2. One important thing to note is that damages awarded from a lawsuit come directly from the organization's resources. In contrast, the 7.5 times loss in market value is not capital being lost from within the firm, but rather other shareholders’ capital being lost.

  3. The accidental fire condition resulted in significantly lower responsibility judgments than the misstatement and embezzlement conditions (p < 0.01).

  4. Several studies have shown that the quality of data gathered through MTurk is comparable to those collected in a more traditional university laboratory setting with the benefit of being more demographically diverse (Brandon, Long, Loraas, Mueller-Phillips, and Vansant, 2014; Buhrmester, Kwang, and Gosling, 2011; Mason and Suri, 2012; Ferrell, Grenier, and Leiby, 2017).

  5. Points for experience are as follows: 0–6 mths = 1; 6–12 mths = 2; 1–5 yrs = 3; 5 + yrs = 4.

  6. The average score of those participants that did not pass the screen was 1.46, and 75% had no prior investment experience, while 21% had less than six months' investment experience. My method of ensuring appropriate expertise by participants was approved by my ethics board (IRB equivalent), it was explained in my letter of information, and I received no complaints from any participants.

  7. I included both time spent and quiz scores as separate covariates in my analyses but did not find any significant time or score effects. Thus, I do not discuss either any further.

  8. Before conducting any tests, I performed factor analyses on the items from the organizational responsibility scale (Brown and Ki 2013). My factor analyses used a varimax rotation, retaining only factors with an eigenvalue greater than one and items that loaded at 0.70 or higher. For the organizational responsibility scale, two factors appeared in the data. The first is the accountability dimension, consisting of three of the six items designed to capture accountability (eigenvalue = 5.39, = 0.89). The second is the intentionality dimension, consisting of the three items designed to capture intentionality (eigenvalue = 1.43, = 0.88). The three items designed to measure the locality dimension of organizational responsibility did not show any significant loadings.

  9. Compared to a baseline condition where the $25 million-dollar loss was attributable to a fire at the factory, both types of fraud result in significantly higher responsibility levels (p < 0.01, unreported), consistent with theory and my expectations.

  10. Given that no information within the materials would indicate the auditors are responsible other than in the scapegoat condition, the level of blame assigned to the auditors by participants in the misreporting condition is surprising. I run a one-way ANOVA with auditor blame as the dependent variable and fraud type as the independent variable. I note that the means for both embezzlement (M = 4.88, SD = 1.54) and misreporting (M = 5.06, SD = 1.48) are significantly higher than the scale midpoint (p < 0.01) but not significantly different from each other (p = 0.29). I interpret these findings as evidence that investors and the general public assume that auditors are responsible for any type of fraud because they believe an auditor's job is to detect fraud, something commonly referred to as the expectation gap (McEnroe and Martens 2001).

  11. For the analysis in which shares traded is the dependent variable, I include participants' pre-manipulation shares traded as a covariate on my model.

  12. I also run a similar model using participant’s confidence about Amrano’s ability to “continue to meet analysts’ expectations for strong growth in revenue and earnings in the foreseeable future” as a proxy for expectations about future price performance. The only difference in results is that the interaction between crisis type and crisis response is significant. All inferences concerning the hypotheses remain unchanged, strengthening my acceptance of H2 and rejection of H3.

  13. I use a composite measure of six questions (= 0.88) about CEO Dan Athens that capture dimensions of trustworthiness like integrity, competence, honesty, and desire to avoid similar issues in the future.

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Acknowledgements

The author wishes to thank Brooke Elliot, Frank Hodge, and Lisa Sedor for sharing their experimental materials. The author also expresses extreme gratitude to Pamela Murphy for help with earlier versions of this manuscript. A previous version of this paper was entitled “Say You’re Sorry: Does Mother’s Advice Apply to Fraud?” The author thanks Allen Blay, Eric Boyle, Nate Cannon, Jody Gissel, Pujawati (Estha) Gondowijoyo, Irene Gordon, Kun Huo, Kip Holderness, Steven Mitsuda, Matt Sooy, Angie Takahashi, Joseph Wall, participants at the 2016 BYU Accounting Research Symposium, the 2017 AAA Forensic Accounting meeting, the 2017 CAAA annual meeting, the 2017 AAA annual meeting, and workshop participants at Ivey Business School, Marquette University and Smith School of Business Social Behavioral Accounting brown bag for comments and suggestions.

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  1. Wilfrid Laurier University, 75 University Ave. W, Waterloo, ON, N2L 3C5, Canada

    Michael J. Wynes

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Appendices

Appendix 1: Fraud Type and Organizational Response Manipulations in Experiment 1

Part A: Crisis Type Manipulations

Accounting Fraud

The SEC announced on Monday that after a month-long investigation into Armano’s accounting policies, they find that the company has been artificially inflating revenues. Armano inflated revenue by $25 million by recording sales prior to product shipment and recording sales for expected purchase orders not yet received from third-party retailers, among other methods. The scheme fueled a string of earnings higher than analyst expectations and a strong rise in the company’s stock, giving Armano a seemingly strong financial position in an otherwise competitive industry. Armano is required to restate its financial statements for the past three years. There is no word yet on whether the CEO Dan Athens or the company will be charged. A lawyer for Armano couldn’t immediately be reached for comment.

Embezzlement

The SEC announced on Monday that after a month-long investigation into Armano’s handling of assets, they find that the company’s CFO, Mark Patras, has been engaging in fraudulent activities to defraud Armano of $25 million over the past three years. Using secret, unauthorized, and improper loans that were later “forgiven” to maintain his extravagant lifestyle, Mr. Patras has pocketed millions of dollars that was concealed from shareholders, the compensation committee of the board of directors, and even CEO Dan Athens. Because the misappropriated funds have been spent, they cannot be easily recovered by Armano. There is no word yet on whether CEO Dan Athens or the company will be charged. A lawyer for Armano couldn’t immediately be reached for comment.

Part B: Crisis Responses to Accounting Fraud

Silence

The associated press has reached out to Armano regarding the accounting fraud that I reported on earlier this week. Armano’s CEO Dan Athens released a statement saying that they have “no comment at this time.” At this time it is still unknown if Armano or any of its executives will be charged.

Scapegoat

Today Armano’s CEO Dan Athens held a press conference to discuss the recent crisis. During his speech Mr. Athens blamed external pressures for the events that lead to the recent accounting fraud. Mr. Athens began his speech by offering the following denial:

To those affected by the recent crisis, I believe that I have not done anything wrong. I acted in such a way to be consistent with how my international competitors record revenues. Thus I engaged in the same sales recognition practice to make the financial statements comparable to my international competitors. This method of recording sales was approved by my auditors.

During the press conference Mr. Athens also discussed the competitive environment in which Armano currently operates. He discussed how strong international competition has forced Armano to try and adjust quickly to changing consumer preferences. To keep up their dominance in the confectionery market, they need to keep their dominance in the stock market by consistently growing revenues. This focus on remaining dominant may have lead to the loss of $25 million in shareholder wealth.

At this time it is still unknown if Armano or any of its executives will be charged.

Apology

Today Armano’s CEO Dan Athens held a press conference to discuss the recent crisis. During his speech Mr. Athens offered an apology for the events that lead to the recent accounting fraud. Mr. Athens began his speech by offering the following apology:

To those affected by the recent crisis, I are deeply sorry for what has happened. I recognize that my desire to keep share prices high does not permit revenue recognition practices that are outside of acceptable accounting standards. I allowed my focus on short-term gains to overshadow my attention to proper accounting. I apologize to my shareholders for whom I have misled. I promise to right this wrong and work harder than ever to regain your trust.

During the press conference Mr. Athens also discussed the competitive environment in which Armano currently operates. He discussed how strong international competition has forced Armano to try and adjust quickly to changing consumer preferences. To keep up their dominance in the confectionery market, they need to keep their dominance in the stock market by consistently growing revenues. This focus on remaining dominant may have lead to the loss of $25 million in shareholder wealth.

At this time it is still unknown if Armano or any of its executives will be charged.

PART C: Crisis Responses to Embezzlement

Silence

The associated press has reached out to Armano regarding the embezzlement of money that I reported on earlier this week. Armano’s CEO Dan Athens released a statement saying that they have “no comment at this time.” At this time it is still unknown if Armano or any of its executives will be charged.

Scapegoat

Today Armano’s CEO Dan Athens held a press conference to discuss the recent crisis. During his speech Mr. Athens blamed internal controls recommended by the company’s auditors. Mr. Athens began his speech by offering the following denial:

To those affected by the recent crisis, I believe that I have not done anything wrong. I share your feelings towards Mark Patras who was able to hide the money he was embezzling from me and the board of directors. The failure of my internal controls, controls that were approved by my auditors, allowed the embezzlement to happen.

During the press conference Mr. Athens also discussed the competitive environment in which Armano currently operates. He discussed how strong international competition has forced Armano to try and adjust quickly to changing consumer preferences. To keep up their dominance in the confectionery market, they need to keep their dominance in the stock market by consistently growing revenues. This focus on remaining dominant may have lead to the loss of $25 million in shareholder wealth.

At this time it is still unknown if Armano or any of its executives will be charged.

Apology

Today Armano’s CEO Dan Athens held a press conference to discuss the recent crisis. During his speech Mr. Athens offered an apology for the events that allowed an executive to embezzle funds. Mr. Athens began his speech by offering the following apology:

To those affected by the recent crisis, I are deeply sorry for what has happened. The company’s weak internal controls allowed the former CFO, Mark Patras, to embezzle company funds. I allowed my focus on the business to overshadow my attention to important fraud control activities. I apologize to my shareholders to whom I have let down. I promise to right this wrong and work harder than ever to regain your trust.

During the press conference Mr. Athens also discussed the competitive environment in which Armano currently operates. He discussed how strong international competition has forced Armano to try and adjust quickly to changing consumer preferences. To keep up their dominance in the confectionery market, they need to keep their dominance in the stock market by consistently growing revenues. This focus on remaining dominant may have lead to the loss of $25 million in shareholder wealth.

At this time it is still unknown if Armano or any of its executives will be charged.

Appendix 2. Organizational Response Manipulations in Experiment 2

The Securities and Exchange Commission announced on Monday that after a month-long investigation, they find that CEO Dan Athens and CFO Mark Patras intentionally deceived investors by misreporting financial information. Over a period of three years, Mr. Athens and Mr. Petras inflated revenues by $25 million by recording sales prior to product shipment and recording sales for expected orders not yet received from third-party retailers, among other methods. The improper revenue recognition practices fueled a string of earnings reports higher than analyst expectations resulting in a strong rise in the company’s stock, giving Armano a seemingly strong financial position in an otherwise competitive industry. Armano is required to restate its financial statements for the past three years.

Silence

The associated press reached out to Armano regarding the fraud. Armano’s CEO Dan Athens released a statement saying: “I have no comment at this time.”

Scapegoating

The associated press reached out to Armano regarding the fraud. Armano’s CEO Dan Athens released a statement saying: “To those affected by the recent fraud, I believe I have not done anything wrong. My revenue recognition practices were approved by my auditor.”

Insincere Apology

The associated press reached out to Armano regarding the fraud. Armano’s CEO Dan Athens released a statement saying: “To those affected by the recent fraud, I are sorry. My revenue recognition practices were not consistent with acceptable accounting standards. This will not happen again.”

Sincere Apology

The associated press reached out to Armano regarding the fraud. Armano’s CEO Dan Athens released a statement saying: “To those affected by the recent fraud, I are deeply sorry. There is no easy way to say it. I engaged in revenue recognition practices inconsistent with acceptable accounting standards, and for that I are genuinely sorry. I promise to right this wrong and work harder than ever to regain your trust and ensure that my focus on short-term gains never again overshadows my commitment to you, the shareholders.”

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Wynes, M.J. “Just Say You’re Sorry”: Avoidance and Revenge Behavior in Response to Organizations Apologizing for Fraud. J Bus Ethics 178, 129–151 (2022). https://doi.org/10.1007/s10551-021-04781-9

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