Fraudulent Financial Reporting and the Consequences for Employees

In this research, Jung Ho Choi, Assistant Professor of Accounting at Standford Graduate School of Business (GSB) and Brandon Gipper, Associate Professor of Accounting at Standford (GSB), combine U.S. Census data with SEC enforcement actions to examine employees’ outcomes, such as wages and turnover, before, during, and after periods of fraudulent financial reporting.

The researchers found that fraud firms’ employees lose about 50% of cumulative annual wages, compared to a matched sample, and the separation rate is much higher after fraud periods. Yet, employment growth at fraud firms is positive during fraud periods; these firms overbuild and hire new, lower-paid employees as part of the fraud, unlike firms in distress which tend to contract. When the fraud is revealed, firms shed workers, unwinding this abnormal growth and resulting in most of the negative wage consequences. Low wage employees, though unlikely to have perpetrated the fraud, experience more severe wage losses. Other sample splits show that negative wage effects are larger in thin labor markets and for fraud firms that go bankrupt.