Correlation Between Executive Pay and Fraud?

Huge pay and benefits for CEOs and other high ranking executives at large public companies can lead some to conclude that fraud is a problem. Could “excessive” executive pay lead to more fraud in companies? It’s possible.

A 2005 study done by the Academy of Management looked at 435 companies that restated financial statements. When compared with similar companies that did not restate their financial statements, they found that companies that used lots of stock options for executives were more likely to have restatements.

In plain English: When executives are rewarded for their work with cheap shares of stock that will likely reap them lots of profits down the road, it’s more likely that the company will have faulty financial statements.

But while this study points to the conclusion I just stated, it’s really incomplete. It doesn’t speak to all types of executive compensation, just stock options. It doesn’t really address the issue of high compensation in general. The study fails to definitively prove that there is a direct correlation between high pay and benefits and the likelihood of fraud. (But it doesn’t disprove it either.)

My experience investigating fraud leads me to believe that greed is often something that is related to both high compensation and fraud. I’ve seen many corporate frauds that were apparently motivated by fraud, and it’s also easy to see how highly compensated executives could develop an entitlement complex along with greedy tendencies.

It’s possible, therefore, that high compensation could encourage greed, which might lead to fraud. Yet there are so many other issues related to fraud by CEOs or other high level executives, that I’m reluctant to say that a direct correlation could be drawn between high compensation and fraud. Any argument for limiting executive pay in order to decrease the risk of fraud is very thin.

Up next: Is executive pay really excessive?

Tracy L. Coenen, CPA, MBA, CFE performs performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.