Financial statement fraud: Learn from the mistakes of the U.S. or follow in the footsteps of its errors

The cost of all frauds - especially financial statement frauds - is extremely high. Classic fraud theory explains the motivations for fraud as a triangle of perceived opportunity, perceived pressure, and rationalization. A model builds upon classic fraud theory, adding various factors to it. Corporate and personal position, compensation-plan structures, and external expectations are three factors that significantly contribute to the element of pressure. The model includes the opportunities of external oversight and monitoring, internal monitoring and control, environmental complexity and the existence of related parties, and the lack of knowledge or education. Rationalizations are measures of the ability people have to defend, explain, or make excuses for their actions. An increased ability to rationalize increases the probability that people will commit fraud. Rationalizations involve the level of personal ethics, environmental ethics, the need to succeed, and rule-based accounting standards. The proposed model provides insight into why financial statement fraud occurs, and it is a useful way for shareholders, board members, and others to think about incentive planning.