Bad Barrel or Bad Apple: The Effect of Ethical Climate on the Likelihood of GAAP Violations

• In Event: Ethical Climate and Determinants

Abstract

Ethical corporate behavior is of great concern to regulators, investors and the public across the globe. Using a novel dataset from Violation Tracker from 2003 to 2019, we seek to examine whether firms that engage in non-financial misconduct (NFM) are more likely to misstate their financial statements. The results are consistent with the ethical climate theory, which suggest that employees’ shared perceptions and beliefs about the ethical substance of the corporate environment, affects their behavior and consequently, firm outcomes. Further analyses show that the positive association between NFM violations and accounting misstatements is mitigated in firms with effective corporate governance, such as financial expertise on the audit committee and the presence of a risk committee, while, it is more pronounced in firms with financial constraints and larger CEO-employee pay disparity. We also show that repeat violators have a higher likelihood of a GAAP violation, which suggests that it is indeed the unethical environment that drives misconduct and not the occasional unethical act. This study uses comprehensive NFM violation data to extend the ethical climate theory and adds to the accounting misstatement literature by providing a new determinant.

Authors

• Tianpei (Constance) Li, Florida Atlantic University

• Maya A. Thevenot, Florida Atlantic University - Boca