Financial misconduct in organisations and countries is seldom the work of a lone rogue executive. Paradoxically, despite its overt nature, it thrives on participation, from boards of directors who turn a blind eye to internal and external auditors who fail to conduct thorough investigations and staff who remain silent.
Perpetuation via this collective collusion may deliver short‑term gains but, in parallel, the immediate and enduring erosion of longer term firm value also occurs.
Short‑term illusion
Financial misconduct can temporarily increase earnings and enhance stock prices, both of which can contribute to significant executive bonus payments. On the side of investors, they are misguided by the massaged figures and concomitantly reward companies with larger valuations and lower financing costs.
Financial misconduct can tear down trust and value, almost overnight
But these gains are an illusion. Financial misconduct is usually exposed and, when it is, firms are faced with sharp market corrections, litigation and negative visibility issues, which all contribute to significant reputational damage. Moreover, customers flee and access to credit diminishes. All these factors contribute to share prices plummeting.
Perpetuation, once clandestine, is now spotlighted – sometimes globally, in the age of social media – and the misconduct cascades towards courtrooms and regulatory investigations.
As is often the case, what may have appeared to perpetuators to be an adroit way to achieve short‑term goals can quickly escalate towards a textbook example of how financial misconduct can tear down trust and value, almost overnight.
Long‑term corrosion
Corrosion over the longer term is even more detrimental. Research confirms that companies tainted by the scourge of financial misconduct struggle to regain the confidence of investors, regulatory authorities and staff.
Capital markets react by the imposition of a credibility discount, contributing to an escalation of financing costs. The diversion of liquidity towards litigation and compliance costs starves research and development and stymies innovation. Human capital is also diminished as the most gifted employees typically leave, not wanting to be associated with a culture of duplicity.
The car manufacturer Volkswagen’s emissions disgrace demonstrates this dynamic. For several years, engineers and managers constructed ‘defeat devices’ to deceive emissions tests, permitting the company to assert environmental leadership and obtain a significant market share. Once the scandal broke, it led to tens of billions of euros in penalties, lawsuits and product recalls.
Further, and significantly more detrimental, was the long‑term hit to the trust associated with the brand. Years after, Volkswagen continues to try to restore trust, diverting significant financial resources from product innovation to crisis and compliance administration.
The well-documented cases of Enron and Wirecard present even more glaring examples. Both entities depended on extensive participation in deceptive reporting. Both fell stunningly, eliminating substantial shareholder value and threatening entire markets. In both cases, financial misconduct was not perpetuated via a one-off error, but facilitated by a total failure of governance, culture and oversight.
Why participation persists
Given the deleterious effects of participation in financial misconduct, why does it persist? The answer may not be straightforward but may lie in incentives and culture. Compensation systems frequently reward executives for surpassing quarterly earnings goals, but not for creating sustainable value.
Moreover, market analysts underline short‑termism by penalising even minor variations from predictions. Company boards often lack independence or proficiency to contest management’s accounting system choices. Staff, stressed by unworkable estimates, may be coerced towards believing that complicity is the only ticket to survival.
Honesty must be firmly rooted in corporate DNA
In such a system, the perpetuation of financial misconduct becomes the order of the day. Engagement is justified as ‘playing the game’ and quietness is compensated more than integrity. The short‑term returns conceal the long‑term costs – but, as history illustrates, only until the scandal breaks.
Thanks to the well-entrenched tentacles of financial misconduct globally, a sudden end is not foreseeable. Nonetheless, the resolution remains in governance and culture. Boards must ensure that incentives are aligned to ensure resistance to short‑term pressures and the creation of sustainable long-term value creation. Those tasked with regulatory oversight must ensure that enforcement occurs, and that those who participate in misconduct face the fullest extent of the law.
External audits and whistleblower protections can also interrupt the cycle of participation. As an absolute priority, companies must strive to develop cultures where integrity is celebrated as much as performance.
The role of technology as an abatement tool should not be underestimated. Complex analytics and AI‑driven audits can discover abnormalities, shrinking chances for manipulation. Blockchain can augment transparency in purchasing and reporting.
However, technology cannot singularly resolve a cultural issue. Bluntly put, honesty must be firmly rooted in corporate DNA.
Concerted action
According to the UNDP, the United Nations development agency, a staggering 5% of global GDP or $2.6 trillion per annum is lost to corruption. International institutions, from the International Accounting Standards Board to the G20, must urgently collaborate to shut down loopholes, harmonise disclosure rules and safeguard capital markets from disintegrating into disjointed havens for transgression. Regulatory oversight bodies must act with expediency, company boards must reject short‑termism, and honesty must be rewarded by investors.
Integrity in financial reporting is critical for the functioning of the capital markets as this underpins the belief of participants in the veracity of the numbers and their accurate depiction of economic reality. If financial misconduct morphs into the norm, markets may resort to being platforms that facilitate stock prices being driven by deception rather than fundamentals. Confidence will be eroded, investments will be discouraged and economic growth will be impeded, negatively affecting the lives of countless individuals.
The time for concerted action is now. The entities tasked with regulatory oversight must enforce transparency, company boards must focus as a matter of priority on integrity and investors must demand accountability. Companies that value integrity as their most prized asset will not only safeguard long‑term valuation but also reinforce the strength of global markets. Going forward, true corporate success must be measured by integrity and not complicity.
