Knowledge and Insights

How Does Corporate Culture Mitigate the Risk of Fraud?

In August of 2021, an Economic News Release from the U.S. Bureau of Labor Statistics reported that 4.3 million American workers had quit their jobs, a number that increased by 242,000 since “The Great Resignation” in April of this year. Experts have credited working conditions, new opportunities to work from home, and toxic corporate culture among the reasons so many people are leaving their jobs.

The COVID-19 pandemic gave many people the opportunity to rethink family values and personal priorities, and more than four million felt their current work simply wasn’t worth it. This has caused major disruptions in virtually every industry. A survey of 117 chief executive officers (CEO), conducted by Fortune, reports that labor shortage is the “most likely external issue” to disrupt business in the next 12 months.

As the inevitable turnover occurs across markets, business owners have to ask some important questions. The obvious questions are: what changes are needed to bring in new talent, and how do we incentivize current individuals to stay? The not so obvious question that can be overlooked is, what impact will this turnover have on our corporate culture and how does this impact our internal controls?

Defining “Corporate Culture”

The term “corporate culture” is nuanced, and may be colored by the perception of employees who have seen it used in either positive or negative ways. For our purposes, corporate culture relates to the beliefs and behaviors that determine how a company’s employees and management interact internally and in outside business transactions.

A strong corporate culture is championed by capable leaders, and most evident in high levels of internal collaboration and accountability. Corporate culture may be seen in tangible ways — such as a mission statement or policies and procedures — or in intangible ways, including attitudes, interactions, and personal preferences.

The Connection Between Corporate Culture and Internal Control

Corporate culture and internal controls are inextricably linked. Numerous studies have been conducted since the early 2000s on the relationship between organizational culture and internal control. These analyses invariably identify a qualitative, constructive relationship between organizational culture and the internal control framework established by the Committee on Sponsoring Organizations (COSO).

COSO outlines five components of internal control: control environment, risk assessment, information and communication, monitoring activities, and existing control activities. While corporate culture impacts all five components of internal control in various ways, the most notable is the impact on the overall control environment.

It is important to observe the commitment to ethical values, competence, accountability and responsibility of people in the C-suite. These qualities have a cascading effect on the other areas of internal control, impacting lines of communication, monitoring, and existing control activities.

Culture is often seen as an element that generates particular forms of organizational control based on common values and beliefs. In other words, when employees within a company share an organizational culture framework, they behave in ways that benefit the company from both a profit and risk assessment standpoint.

Our professionals at Mercadien have witnessed the impact of culture along the continuum best described as a dark side and light side as follows:

The Dark Side

We may see a client with a rigidly siloed organization, which has a lack of accountability in the finance department. Leadership is unresponsive, and no one else wishes to take responsibility for anything even marginally outside the scope of their role. This can happen in a team of any size, and is a huge red flag that poor culture could increase the risk of fraud.

The Light Side

On the other hand, we may see clients whose company culture is driving positive patterns. A CFO and controller may take high levels of responsibility, but are also willing to loop in any relevant team member who may have a good contribution to make in a discussion or decision. They have strong leadership and ethical values and invite collaboration from their team members. This fosters trust and increased levels of communication within the department. Performing a risk assessment of a company like this will take into account how that culture reduces the likelihood of dishonest employee behavior.

Addressing the Fraud Triangle

The goal of any internal control framework is to develop policies, procedures, and behaviors that prevent, detect, and correct errors or fraud in a timely manner. When it comes to fraud in particular, it is important to consider the opportunities, pressure, and rationalizations that make up the fraud triangle:

  • Siloes, broken lines of communication, and departmental demarcation increase opportunities to commit fraud.
  • Pressure is often driven by a cutthroat, competitive culture. If people feel undue pressure, they may fudge numbers to not incur consequences.
  • Lastly, if employees feel slighted or underappreciated, they are more likely to rationalize fraudulent behavior.

According to the Association of Certified Fraud Examiners 2020 Report to the Nations, 43% of occupational fraud in 2020 was initially detected by a tip. Of those tips, 50% were from internal employees, which makes up the largest single identifier of occupational fraud. This is why it is important to build a corporate culture that fosters trust and open communication comes into play. In a culture with open lines of communication to trusted senior management, employees feel empowered to report suspicious activities.

As fully remote teams become more common, we are spending more time assessing risk related to the remote environment and how traditional control structures have been impacted. Not only have processes for review and approval of expenditures changed, but the way in which teams communicate has been greatly impacted. This impact is often a decrease in communication, which can greatly increase the opportunity, pressure, and rationalizations that make it easier for employees to commit fraudulent acts.

A poor corporate culture can result in a lack of eager, incoming talent and an uptick in employee fraud. If these symptoms show up, it may be time for a reset.

How to Reset Corporate Culture

In any field, in businesses of any size and age, corporate culture is fluid. It shifts based on the people who occupy different roles. This change is inevitable, and, frequently, corporate culture will need to be reassessed and even reset.

Here are some tips for resetting corporate culture:

Take stock. Perform a SWOT analysis: every company is facing limitations, but what is yours doing well, and what is it not doing well?

Identify weaknesses. Depending on company structure, the chain of command may have weak links, or be staffed by people who aren’t bought into the vision or team. What can be done to shore up weaknesses?

Roadmap a plan based on opportunities. Staying aware of how happy employees are (or are not), can mitigate the risk of fraud and bring overall improvements to efficiency and productivity.

Don’t forget that threats are real. While unfortunate, employee fraud does happen. Anonymous fraud tip lines and fraud awareness training are two mechanisms that assist in the prevention and detection of fraud. A strong corporate culture supports both of these mechanisms and allows employees to feel comfortable with the act of reporting any potential wrongdoing.

Key Takeaways

No leader can ignore the fact that company culture is directly related to risk management. Culture must be a priority, first among leadership groups and then through the company as a whole. Even if an effort to this end requires course correction and change management, it is an investment worth making.

The Mercadien Group is a dedicated team of professionals, working in numerous roles to support the overall financial health and prosperity of businesses. For Assurance, Business Advisory, Tax Services, Accounting, Wealth Management, or more: contact us today.

DISCLAIMER: This advisory resource is for general information purposes only. It does not constitute business or tax advice and may not be used and relied upon as a substitute for business or tax advice regarding a specific issue or problem. Advice should be obtained from a qualified accountant, tax practitioner or attorney licensed to practice in the jurisdiction where that advice is sought.