White-collar money laundering through opportunistic earnings management: fair value accounting practices of failed finance companies in Sri Lanka
| Date | 13 December 2022 |
| Pages | 1389-1417 |
| DOI | https://doi.org/10.1108/JFC-09-2022-0233 |
| Published date | 13 December 2022 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial crime |
| Author | S.G. Sisira Dharmasri Jayasekara,Wasantha Perera,Roshan Ajward |
White-collar money laundering
through opportunistic earnings
management: fair value
accounting practices of failed
finance companies in Sri Lanka
S.G. Sisira Dharmasri Jayasekara
Financial Intelligence Unit, Central Bank of Sri Lanka, Colombo, Sri Lanka
Wasantha Perera
Department of Finance, Faculty of Management Studies and Commerce,
University of Sri Jayewardenepura, Nugegoda, Sri Lanka, and
Roshan Ajward
Department of Accounting, Faculty of Management Studies and Commerce,
University of Sri Jayewardenepura, Nugegoda, Sri Lanka
Abstract
Purpose –The purpose of this paper is to discuss howthe failed finance companies in Sri Lanka used fair
value accounting practicesas an opportunistic earningsmanagement practice to launder money under weak
corporategovernance structures.
Design/methodology/approach –This paper uses a qualitative design under the philosophy of
interpretivism.The case study research strategy is used inductively to investigatehow fair value accounting
had been used formoney laundering.
Findings –The dishonest intention of major shareholders and board of directors had forced failed
companies to misuse fair value accounting to manipulate performance and use them for personal benefits
which were detrimental to the depositors and stability of the companies. The weak corporate governance
structures which were developedbecause of regulatory forbearance were influential for manipulations. The
concentrated ownership had reduced agency conflicts between shareholders and managers because major
shareholders were the members of the board of directors. The appointed committees were not effective
because of an inadequate number of independent directors with sufficient expertise. The reduced agency
conflict between shareholdersand managers has exaggerated the agency conflict withdepositors. Therefore,
it is recommended to dilute ownershipconcentration to establish good corporate governancestructures and
make stableinstitutions.
Research limitations/implications –This study does not discuss the dishonest fair value
accounting practices of all licensed finance companies because of the sensitivity of the matter for
surviving companies.
Originality/value –This paper is an original work of the authors which discusses how fair value
accountingpractices had been used to launder money in failed financecompanies in Sri Lanka as an emerging
market context.
Keywords Money laundering, Intention, Fair value accounting, Value information,
Opportunistic earnings management, Weak corporate governance structures
Paper type Research paper
White-collar
money
laundering
1389
Journalof Financial Crime
Vol.30 No. 5, 2023
pp. 1389-1417
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-09-2022-0233
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
1. Introduction
Fair value accounting is presumed to provide timely and relevant financial information to
the users of financial statements which is useful in making informed decisions. In such a
context, earnings management practices raise concerns over the quality of information.
When firms manipulate theirearnings, they can use not only accrual earningsmanagement,
which is done through applying different accounting methods, but also real earnings
management, which is achieved through real operation activities or transactions (Li et al.,
2020;Shoaib and Siddiqui, 2020). Therefore, managers can use fair value accounting
practices for earnings management instead of accruals. Barth et al. (1995) find that fair
value–based earnings are more volatile than historical cost earnings and banks violate
regulatory capital requirements more frequently under fair value than historical cost
accounting. This volatility provides an opportunity for financial institutions to manipulate
capital using fair values.
Healy and Wahlen (1999) show that earnings management occurs when managers use
judgment in financial reporting and in structuring transactions to alter financial reports to
either mislead some stakeholders about the underlying economic performance of the
company or to influence contractualoutcomes that depend on reported accounting numbers.
Ghazali et al. (2015) state that earningsmanagement also goes toward an opportunistic view
where managers manage earnings for their private benefits rather than for the benefits of
the stockholders. Agency theoryalso suggests that strong corporate governance structures
reduce agency problems and improve the quality of earnings (Thesing and Velte, 2021).
Therefore, weak corporate governance structures force managers to behave dishonestly
where the intention of the managers is important in determining the criminal aspect of the
earnings management practice. Dishonest intention and use of fair values may generate
criminal proceedsand usage of such generated proceeds could be money laundering.Having
developed a new transaction management (TRM) proxy to find empirical evidence of the
strategic management of accounting transactions, Ravenda et al. (2019) find evidence that
different TRM practices are used for specific money laundering activities. These are
structured transactions which were intended for money laundering. However, this study
focuses on fair value accounting practices which were used in failed finance companies
under weak corporate governance structures for money laundering. However, prosecution
for money laundering for complicated accounting scandals is challenging due to a lack of
evidence given the complexity and technicality of frauds (Perera et al.,2021). Sri Lanka
experienced failures of some licensed finance companies during the 2008/2009 period and
later due to various reasons including accounting malpractices, fraudulent activities,
mismanagement (CBSL,2018) and weaknesses in corporate governance structures (CBSL,
2020). This study discusses only the fair value accounting malpractices of failed finance
companies to avoid creating issues for surviving companies which may be detrimental to
the rights of depositors.In summary, the main contributions of the study are the following:
This study reveals that the weak corporate governance structures were significant
factors for the manipulation of performance adopting fair value accounting
practices to launder money. Therefore, the regulatory regime of the country needs to
be strengthened to improve the corporate governance practices among the licensed
financial institutions ensuring effective implementation and monitoring.
Regulatory forbearance and politicization of the regulatory regime were influential
in making corporate governance structures weak. The concentrated ownership has
reduced the agency conflicts between shareholders and managers. However, the
weak corporate governance structures and reduced agency conflicts between
shareholders and mangers has exaggerated the agency conflicts between
JFC
30,5
1390
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