Competition, Cost Analytics, and Offsetting Strategies: Pressures and Opportunities on the Fraud Triangle
Du Pon, Adam Watanabe
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This study introduces industry competition factors to fraud models to examine how competition associates with fraud risk. I argue that industry competition eclipses many firm-level determinants in their association with fraud risk, and that the cost of poor information elevates fraud risk as competition increases. I find that fraud risk is higher for firms in industries with 1) more substitutable products and services, 2) greater threats of new entry, and 3) larger incumbent pools of competitors, and that substitution exceeds every firm-level variable except size in its relevance with fraud risk. Cross-sectionally, I provide evidence that industry-wide non-adoption of advanced cost analytics (i.e. using obsolete, distortionary standard costing practices) may exacerbate the fraud-risk effects of competition, especially product substitution: a one standard deviation increase in substitution associates with over double the fraud risk for firms in industries typified by obsolete costing practices. I also find that different strategies vary in their fraud-offsetting associations dependent on the type of competition most prevalent in an industry. Together, these findings shed light on how the effects of industry competition may subsume or surpass most firm-level fraud determinants and provide evidence of previously unidentified drawbacks of obsolete cost accounting systems.
General Audience Abstract
Elements of industry competition help explain a firm's fraud risk. I find that bringing competition variables into firm-level fraud models helps explain a large portion of the firm's fraud risk, and that the effects of competition more strongly associate with fraud risk than most firm-level attributes. The results also indicate that the effects of competition on fraud risk may be even worse in industries where obsolete cost accounting practices remain widespread: the effects of price competition in such industries associates with significantly greater fraud risk than in other industries. Additional findings include the implied fraud-risk-reducing effects of different business strategies, depending on which type of competition is most intensive around a firm. Altogether, this study sheds light on the importance of including industry competition effects when assessing fraud risk, especially when a firm's or its peers' cost accounting system quality is poor and price competition is high.
- Doctoral Dissertations