What is it about?
The paper asks how practices that are now illegal spread between organizations before they become explicitly outlawed. To answer this I trace the diffusion of a specific type of financial fraud – stock option backdating, and look at two potential channels that can spread the practice: proximity to firms that have already backdated, and ties to a local office of an audit firm whose clients have backdated. The findings point to two interesting results. The first is that while backdating spreads from one firm to another, having a lenient auditor explains much of the diffusion of the practice than being close to other, backdating firms. What is interesting here is that the reason this was not observed in prior research is that the diffusion happens at the level of the local office of the external auditor (meaning it spreads within cities), rather than at the national level (or between cities). The second is that, depending on the legal environment, local offices of auditors either spread the practice or curtail it.
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Why is it important?
The cost of engaging in illegal practices is high, both for the adopting organizations and their auditors. In this paper, I trace how such practices spread, what conditions change the pattern of their diffusion and who are the actors that spread or curtail these practices.
Perspectives
The responsibility of auditors to their client's wrongdoing has been a topic of heated debate long before I started doing research (indeed, even before I was old enough to read or write). Still, in the months before this paper was published calls to "break up" auditors because of gross client misconduct have resurfaced in the U.K. and around the world. What I hope this paper adds to this debate is some evidence that when it comes to liminal practices (practices that are skirting the line between what is right and what is legally forbidden), the idea that auditors behave as a unified entity might be too simplistic. Multi-office professional service firms may, in fact, already look more like a collection of independent firms than like one unified company. As the diffusion of backdating suggests, local offices of different auditors may have very similar patterns of client backdating than other local offices of the same auditor. Although the structure of the audit company is at the center of recent debates on curtailing organizational wrongdoing, what seems to have the largest effect on whether auditors will or will not curtail client backdating is the clarity of the legal environment. Once the regulation around reporting stock option grants becomes clearer, the vast majority of auditors curtail backdating among their clients. Perhaps it would be useful to pay more attention to drafting simple, clear regulation.
Dr Aharon Mohliver
London Business School
Read the Original
This page is a summary of: How Misconduct Spreads: Auditors’ Role in the Diffusion of Stock-option Backdating, Administrative Science Quarterly, March 2018, SAGE Publications,
DOI: 10.1177/0001839218763595.
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