“Culture of Weak Compliance and Financial Reporting Risk” by Dr. Shuqing LUO
Dr. Shuqing LUO
Assistant Professor of Accounting
NUS Business School
National University of Singapore
Prior work has under-emphasized the role of deviant organizations (“bad barrels”) in favor of the role of deviant individuals such as senior managers (“bad apples”) in explaining corporate misconduct. We seek to redress that imbalance by investigating whether a weak culture of compliance is associated with financial misreporting risk. We measure weak culture of compliance using firm-level data for the years 1994-2011 covering 22,885 firm-years related to enforcement activities of the Food and Drug Administration (FDA), the Department of Justice (DOJ), Federal Trade Commission (FTC), Mine Safety and Health Administration (MSHA), Occupational Safety and Health Administration (OSHA), Office of Federal Contract Compliance Programs (OFCCP), Wage and Hour Division (WHD), and the Environmental Protection Agency (EPA). As predicted, we find a statistical and economically significant association between such a weak compliance culture and a firm’s proclivity to start financial misreporting, proxied as earnings restatements, SEC AAERs, and securities class action lawsuits. Additional analysis suggests that a weak compliance culture is associated with higher equity based compensation for the CEO, a weaker internal control environment and weaker governance, a lower threat of a takeover, a diversified organizational structure, and a higher level of CEO dominance.