The dark side of blockholder control: evidence from financial statement fraud cases
| DOI | https://doi.org/10.1108/JFC-05-2021-0113 |
| Published date | 05 July 2021 |
| Date | 05 July 2021 |
| Pages | 816-835 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial crime |
| Author | Nadia Smaili,Paulina Arroyo,Faridath Antoinette Issa |
The dark side of blockholder
control: evidence from financial
statement fraud cases
Nadia Smaili,Paulina Arroyo and Faridath Antoinette Issa
Department of Accounting Studies, School of Management,
University of Quebec in Montreal, Montreal, Canada
Abstract
Purpose –The purpose of this study is to investigate whether large blockholders are associated with
financial statement fraud at their companies. Although a substantial body of prior studies has focused on
chief executive officers’motivations to manipulate financial statements, the correlation between majority
shareholders and financial statement fraud has received little attention.This paper aims to fill this gap by
investigating whether the sample firms have controlling shareholders or executives (i.e. blockholders vs
management) and whetherfinancial statement fraud schemes, motivations and consequences differbetween
blockholder-and management-controlled firms.
Design/methodology/approach –Using a clinical approach, the authors Study12 Canadian financial
statementfraud cases uncovered by the Ontario Securities Commissionbetween 1997 and 2020.
Findings –First, the authors find blockholder control in six cases. These findings infer that these large
shareholders received private benefits at the expense of minority shareholders. The comparative analyzes
suggest that fraudulent firms controlledby blockholders go bankrupt more often than those controlled by
managers. The authors also find that improperdisclosure is the most common fraud scheme in blockholder-
controlledfirms.
Originality/value –The authors conducta deep analysis of financial statement fraud cases to examine the
of blockholder control on the likelihood of financial statement fraud. This paper adds new insights to
the researchon financial crime by investigatingwhether large shareholders affect the probabilityof fraud and
the extent to which theymight do so.
Keywords Fraud crime, Financial statement fraud, Blockholder, Management,
Management control, Blockholder control
Paper type Research paper
1. Introduction
Fraud cases have skyrocketed since the early 2000s, leaving staggering costs in their
wake. Stories of top managers who take advantage of their position and power to
embezzle funds from their company and its shareholders are now commonplace. The
2016 global economic crime survey documents that 36% of the world’scompanies
reported being victims of financial crime during the previous year. The 2020 Global
Fraud Study conducted by the Association of Certified Fraud Examiners (ACFE)
reports that companies lose an average of 5% of their annual income due to fraud and
that fraudulent schemes resulted in losses of more than US$3.6bn (Association o f
Certified Fraud Examiners [ACFE], 2020).
These surveys suggest that fraudhas become a recurring event and a pervasive threat to
any organization irrespectiveof its sector of activity and size. Furthermore, the cost of fraud
tends to be associated with the fraudster’slevel of authority. The 2020 ACFE report shows
that fraud perpetratedby owners and executives accounted for only 20% of corporatefraud
JFC
29,3
816
Journalof Financial Crime
Vol.29 No. 3, 2022
pp. 816-835
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-05-2021-0113
The current issue and full text archive of this journal is available on Emerald Insight at:
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cases, yet the median loss associated with their maneuvers amounted to US$600,000,
indicating the high cost of fraud by those in positions of power. This study will focus on
fraud cases involving these powerful majority shareholders and top managers, as they are
usually in a better position to override controls than lower-level employees are. They also
have greater access to the organization’s assets, which could explain why they can inflict
greater losses.
Prior studies that examined corporate fraud mainly focused on the fraudulent and
opportunistic behavior of top management (Beasley, 1996;Farber, 2005). However, several
empirical studies show that ownership is concentrated among a small number of majority
shareholders (Maury and Pajuste, 2017;La Porta et al., 1999;Barca and Becht, 2001). This
type of ownership structure creates a double agency issue in addition to the traditional
principal-agentissue.
Not only the presence of a major shareholder or large blockholder creates benefits
but also comes with some inconveniences for minority shareholders. On the one hand,
majority shareholders can benefit minority shareholders by better monitoring
managers and reducing traditional agency problems between shareholders
(principals) and managers (agents) (Maury and Paju ste, 2017; Shleifer and Vishny,
1997). On the other hand, majority shareholders might pursue their own interests, and
thus cause harm to the minority shareholders, the organization and stakeholders
(Shleifer and Vishny, 1997;Bukart et al., 1997). Based on these arguments, several
studies suggest that blockholders may extract private benefits while they control and
monitor management. They will act in their own interests, at the expense of minority
and other types of shareholders (Barclay and Holderness, 1989;Dyck and Zingales,
2004). If one agrees that large blockholders could harm organizations by pursuing
their own interests, it follows that their presence could potentially be linked to the
likelihood of financial statement fraud. We investigate this possible correlation by
looking at the two major issues in accounting we have just mentioned as follows: the
presence of large shareholders (benefits and inconveniences) and financial statement
fraud.
Prior studies emphasizing the effect of management control on financial statement
fraud mainly investigated the fraud motivations of top managers, particularly the chief
executive officer (CEO) (Beasley, 1996;Armstrong et al., 2010;Beasley et al., 2010;
Dechow et al.,2010;Amiram et al., 2018). While the existence of two types of cont rol,
management and majority shareholders’control, may be mentioned, those that explore
their impact on the likelihood of financial statement fraud rarely concentrate on the
latter party (Beasley, 1996;Beasley et al., 2010). The scarce studies that do look at
blockholders find that they have no significant effect on financial statement fraud.
We suggest that this lack of effect can be explained by the fact that large blockholders
have two opposite effects. As suggested by prior studies on fraud, they play a
governance role and thereby reduce agency issues by controlling management.
However, we suggest that they also could have a considerable influence on financial
statement fraud by colluding with management to pursue their owninterests and harm
minority shareholders.
The objective of this paper is to conduct a deep analysis of financial statement fraud
cases to examine the role of management and blockholder control on the likelihood of
financial statement fraud. We address some of the most well-known Canadian cases that
have harmed investors and the public. The study of these cases sheds light on the most
common type of fraud experiencedby organizations in Canada, the accounting schemesand
motivations of the perpetrators, the economic consequences of fraud and the authorities’
Dark side of
blockholder
control
817
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