Corporate Social Responsibility and Corporate Fraud

Theoretical background and hypothesis

Purpose : This study aims to examine the impact of corporate culture, measured by corporate social responsibility (CSR), on the likelihood and severity of corporate fraud. CSR literature indicates that corporate managers are moral actors and are obliged to exercise their discretionary decisions according to their moral standards. Based on the moral development theory, this study argues that higher managers’ ethical values reflected by higher CSR activities are less likely to commit fraud and have lower severity of fraud.

Design/methodology/approach : This study argues that at the firm level, corporate culture can be measured by firms’ CSR activities. Using probit, match-pair, propensity matching and Heckman regressions on a sample of 152 criminal corporate fraud cases in the USA from the US Department of Justice (DOJ) during 2000 and 2010, this study empirically examines the impact of CSR, CSR strengths and concerns scores on the likelihood and the severity of corporate fraud.

Findings : Firms with higher CSR and CSR strengths (concerns) scores have lower (higher) likelihood and lower (higher) severity of corporate fraud. This study finds that firms with higher community, employee, environment and product-related CSR have lower likelihood of fraud, and firms with higher diversity, employee, environment and product-related CSR have lower fraud severity.

Practical implications : Establishing a positive corporate ethical culture is essential to curb the outbreak of corporate fraud that threatens our societal norms. The findings also shed some light for investors, corporate board of directors and regulators to consider CSR as a reflection of top managers moral values that is negatively related to the occurrence and severity of corporate fraud.

Social implications : Strengthening moral values among top executives and employees in corporations by encouraging CSR activities aid our society to alleviate future outbreak of epidemic problem for corporate fraud.

Corporate fraud has become the center of public concern, including but not limited to regulators, investors, board of directors and academics. Since the outbreak of corporate scandals in 2000 and the 2007 financial crisis, there have been increasing regulatory restrictions and scrutiny to reduce the opportunity and incentive for corporate fraud. However, according to the PricewaterhouseCooper (2016) (PwC) report, the economic
crime across the globe still represents more than a third of all criminal activities. The Federal Bureau of Investigation (FBI) (2011) also reported that pending cases for corporate fraud in the USA continue to rise in recent years. Therefore, despite increased regulations, corporate fraud seems to be a serious continuing epidemic problem.

Given that the increased regulatory restrictions has not been quite effective to prevent corporate fraud, we turn our attention to the social psychology literature that examines the development of individual (un)ethical in a group setting (Baldwin, 1906; Kohlberg, 1969). Kohlberg (1969) indicates that moral and ethical views for adults are formed based on abstract reasoning of universal ethical principles that are shaped from collective ethical consensus of a group. Trevino (1986) extends Kohlberg’s theory and argues that organizational culture influences (un)ethical behavior. Trevino (1990) indicates that the thoughts and actions of individuals in organizations are influenced by organizational
culture, and individuals can act and operate according to different standards and criteria depending on the context and socialization processes in organizations. Jones (1991) indicates that moral intensity activities in a corporation have significant effect on employees’ (un)ethical decisions. Rockness and Rockness (2005) indicate that a strong corporate culture plays a significant role for establishing corporate ethical actions. Kaptein (1998, 2011) finds that unethical behavior by employees and managers was caused by a failing organizational culture.