In the wake of the many corporate misconduct scandals, activist investors and constant media scrutiny, a wide consensus on the need for robust corporate governance, transparency, and new roles for board of directors has emerged.
A corporate scandal can ensue whenever evidence of unethical behaviour, negligence, or third-party interference impacts on reputation. Studies suggested that these have resulted in several regulatory corrections, which expanded the requirements on public corporations’ board of directors, management, and accounting firms.
Before reflecting on these corrections, it is imperative the causes of such scandals, as well as their consequences, are ascertained.
A three-layered set of reasons
Since 1953, research has tried to explore the inducements that lead to individuals’ unethical and fraudulent behaviour. Among these was one by Donald Cressey, a criminologist, who defined the “Fraud Triangle Model”. According to it, the incentive to commit fraud can arise from three elements - financial and non-financial pressures such as losses, greed or personal debt; the need to meet stakeholders’ expectations; and social recognition.
Secondly, the availability of opportunities to commit fraud and bury it, which arise from a weak governance structure, inadequacy of internal controls, and an incompatible control environment.
Third, rationalization, in which the fraudster concludes that gains from such activity outweigh all other aspects, coupled with the justification to undertake this misconduct.
Furthermore, the narcissist theory asserts that executives with high levels of self-confidence are more likely to commit fraud to preserve a positive image of themselves or their corporates.
A price to pay
Notably, corporate scandals hinder the economic, social, and financial growth of a country by impeding investments, raising the cost of the transactions, and creating uncertainty in the investment environment.
Further, these scandals can hamper the corporate, the industry and the host country’s reputation. For example, the fraudulent fixing of emissions and fuel-efficiency tests by Volkswagen dealt a significant blow not only to the automaker, but also to Germany’s industrial reputation.
Additionally, the Fukushima disaster divulged significant shortcomings in the official supervision of the nuclear industry and Tokyo Electric Power Co.’s management of the nuclear plant, and arguably sabotaged Japan’s reputation for integrity.
In the UAE, NMC, the country’s largest private healthcare company, has become the latest corporate to be involved in a financial scandal related to fraudulent asset values and theft of company assets. NMC’s scandal follows two others, involving private equity firm Abraaj and the construction contractor Drake & Scull International.
An incentive to mend
Taken together, these scandals potentially undermine the UAE financial sector’s reputation. However, despite the ramifications for the individual sectors and associated industries in the UAE, they are also persuading regulators to undertake measures that plug gaps in corporate governance. This will lead to better countering such problems at an early stage, and further strengthen regulations.
A report on occupational fraud and abuse by the Association of Certified Fraud Examiners found that in 2019 organizations lost 5 per cent of their annual revenues to frauds, which equals to the loss of more than $4.5 trillion of 2019 Gross World Product (GWP).
Further, such scandals represent a considerable decline for stock prices and debt ratings. This will have a contagion effect, which will transfer the spillovers of shocks from one entity to others and impact an entire sector.
Corporate scandals have brought forth changes in the form of new regulations to prevent future scandals in other countries. An illustration of this can be taken from the US, where the Congress implemented regulations to safeguard the reputation of US accounting firms after the Arthur Andersen and Enron fiasco.
In others, government reforms focused on prevention by establishing programmes to avoid illegal activities. One of these is “whistleblowing” from within an organization, in which incentives are offered to employees to inform regulators of any illegal activity occurring within.
In a nutshell, corporate scandals can occur from different causes. But once they occur, the impact can last for a proverbial eternity.
- Juwhra Salem is a UAE-based writer.