Welfare-enhancing fraudulent behavior
David E. M. Sappington
Received: 1 February 2013 / Accepted: 30 May 2014 / Published online: 19 June 2014
Ó Springer Science+Business Media New York 2014
Abstract We demonstrate that an increased likelihood of fraud within an orga-
nization can beneﬁt both the organization and its auditor. This is the case even
though undetected fraud always harms both the organization and the auditor. The
increased likelihood of fraud can induce the auditor to increase his auditing effort,
which reduces the equilibrium incidence of undetected fraud and thereby beneﬁts
both the organization and the selected auditor.
Keywords Welfare Á Fraud Á Earnings management Á Auditing
JEL Classiﬁcation D60 Á D73 Á G32 Á M42
Corporations devote substantial resources to limiting the potential for internal fraud.
Therefore it is natural to presume that an increased potential for fraud will always
harm a corporation. The purpose of this research is to demonstrate that this
presumption is not always correct. We consider a stylized model of auditing in
which undetected fraud within a corporation is harmful both to the corporation and
to an auditor who fails to uncover the fraud. We show that, despite the losses that
fraud imposes, both parties can gain from an increased likelihood of fraud.
H. Lin (&)
University of Houston, Houston, TX, USA
D. E. M. Sappington
University of Florida, Gainesville, FL, USA
Rev Account Stud (2015) 20:343–370