Financial Fraud: Impact on National Economies - Essay Example

? Financial Fraud: Impact on National Economies 29th, June Introduction Financial fraud involves failure to adhere to the set standards in financial dealings. Nonetheless, this injures the affected company or institution in a negative way. The negative impact is also transferred to the national economy and the people therein. Therefore, since national economies contribute to the global or international economy, financial frauds anywhere will result in a negative impact on the international economy. For this reason, financial fraud is a significant aspect in international finance, as this has a negative impact on the elements of international finance. Although different countries have developed measures of addressing financial fraud, these have not been effective. Therefore, it is important that effective strategies are developed to address financial fraud. This paper analyses the field of international finance, and addresses financial fraud, and its impact on national economies. Theories are adopted to show how the factors determine financial fraud, and future research needs on the topic are identified. An Analysis of the Field of International Finance International finance mainly focuses on aspects of foreign investments and exchange rates, including how these aspects influence international trade (Das, 1993). Therefore, in international finance, the affairs of government institutions are of core importance, including how their investments influence the value of a country’s currency in international markets. The field of international finance is therefore, important, as this influences different aspects of national economies today. International finance, which also involves international finance markets, is key to the operations of multinational companies (Kumar, n.d). Therefore, understanding international finance will help multinational companies to manage the risks they are exposed to, and take advantage of various opportunities, which different activities in the international markets present to them. In addition, knowledge of key concepts in international finance, such as international interest rates, and exchange rates, among others might help multinational companies to deal with the different issues, which arise due to the involvement of the companies in international transactions. Furthermore, knowledge on international debt and security issues, are important in helping a company strategize for its foreign direct investments and management (Das, 1993). Due to the high importance of international finance, there are different issues and debates, which have arisen in this field. The main issues in international finance today include financial liberalization, capital controls, and exchange rates (Hansanti, Islam & Sheehan, 2008). Additionally, there is a debate on standards and transparency in international finance. With regard to financial liberalization, today is the new age of global capital markets, in which most international investment funds are aimed at the developing countries. It is considered that integrating the capital markets is essential, in order for the developing countries to also benefit from the process of globalization, which the capital markets are experiencing (Boerner, 2009). However, some developed countries are objected to this approach of financial liberalization, arguing that some developing countries have become vulnerable economically, due to the integration of financial markets and financial liberalization (Hansanti, Islam & Sheehan, 2008). Nonetheless, most economic scholars argue that this approach of financial liberalization highly contributed to the economic and financial crisis experienced in the international economy. This is based on the fact that although this approach benefits developing countries, it also results in them being economically disrupted. Therefore, debates have persisted on the choice of an alternative approach of financial liberalization, which will offer effective results (Hallwood & MacDonald 2000). Capital controls is another important issue in international finance today. Although capital controls has the capability of offering numerous economic opportunities, some powerfully-connected companies have abused these opportunities for their own interests in order to maintain their dominion in the financial sector (Hansanti, Islam & Sheehan, 2008). Both developing and developed countries today have experienced increased capital controls. This is owed to the strong force of globalization, which has attracted many investors and borrowers in the global financial market. However, the integration and liberalization of financial markets has presented a major challenge for policymakers to develop adequate controls of capital flow. Therefore, scholars in this field have debated on the implementation of two major capital control flows, namely; controls on capital outflows and control on capital inflows. Another important issue in international finance is exchange rate policy. According to Hansanti, Islam & Sheehan, (2008), it has been challenging to choose between flexible and fixed exchange rates in international finance. However, some scholars have argued that this is a choice between absolutes. Mundell (1961) and McKinnon (1963) have argued that it might be impossible to make one choice that will equally benefit both the developed and developing countries. For instance, the open economies of most developing countries might make it challenging for them to adopt fixed foreign exchange rates. Therefore, in international finance, there continues to be a debate on the most appropriate foreign exchange rate, between fixed and flexible exchange rates. Nonetheless, despite conflicting opinions on the issues in international trade, it is widely accepted that domestic financial should be given precedence over other issues. In order to prevent financial crises in international finance, there is a debate on the need for greater transparency and disclosure of financial information and activities of domestic companies, financial markets, and international financial institutions (Eichengreen, 2009). This allows for investors to make informed decisions, markets to lend wisely, and governments to develop effective strategies for regulation and supervision of financial institutions. Although some stakeholders argue that transparency of information is insufficient to prevent financial crises, others have argued that this promotes a healthy financial system. With regard to financial reporting, it is argued that effective standards be adopted to avoid fraudulent reporting by financial institutions. However, present standards have not been effective in addressing fraudulent reporting of banks and other financial institutions. Therefore, this remains a major area of debate in international finance. Research Topic Financial fraud is among the major forms of corruption, which countries experience today. In the past, business newspapers and magazines contained various news items relating to corruption. Financial fraud was the most prevalent form of corruption reported, and mainly comprised fraudulent financial reporting (Albrecht, Albrecht, & Dolan, 2007). Today, financial fraud remains one of the major forms of corruption, which countries continue to fight. According to Isa (2011), when there is manipulation of financial information, which leads to losses in a company, this situation is referred to as financial fraud. The major effects of financial fraud include bankruptcy and crumbling of financial institutions, including private and public. Although it is possible to prevent financial fraud, auditors today continue to face the challenges, which financial fraud presents, as they continue to develop strategies that might effectively address this issue. Apart from influencing financial institutions detrimentally, financial fraud also has considerable effects on the economies of different countries, and the overall global or international economy. These effects impact negatively on the economy, as financial fraud is costly. According to Albrecht, Albrecht & Dolan (2007), financial fraud can be likened to a form of cancer, which eats away productivity of a country. It leads to the slowing down of effectiveness and efficiency of economies, and is costly for the affected individuals, as well companies to deal with. Therefore, it is important that research be conducted on this issue, in order to contribute to the realization of its possible solutions. For this reason therefore, this paper addresses financial fraud, and the effects this has on the economy, since this is an important issue to the international economy, which is struggling to strengthen today. There are different models and theories, which attempt to provide an explanation of why people commit financial fraud. Therefore, from these theories, it is possible to learn some of the motivating factors, which lead individuals to commit financial fraud. If companies and individuals business owners can learn and use these theories of fraud, they will be in a better position to implement a risk assessment plan, and implement adequate preventive and detective strategies (Albrecht, Albrecht & Dolan, 2007). Different people can commit financial fraud, despite of their ranks in a company. Therefore, a C.E.O is just as capable of financial fraud, as an ordinary employee. However, upon employment, no individual comes with a motive of engaging in financial fraud. Hence, the theories of fraud attempt to inspect why good employees become “bad,” by committing financial fraud, and what motivates them. The first theory of why employees commit financial fraud is the one based on the study of Hollinger and Clark in the year 1983. In their study, Hollinger and Clark interviewed about 12,000 employees in the workforce. Findings from this study showed that most employees, close to 90%, were involved in “workplace deviance.” In this case, workplace deviance includes behaviors at the workplace, such as pilferage, workplace slowdowns, abuse of sick time, as well as goldbricking. The findings also showed that one-third of the employees had committed theft of company money or equipment. In addition, true costs were highly understated (Hollinger & Clark, 1983). With regard to the theft of employees, Hollinger and Clark identified a direct correlation between age and theft. Younger employees rarely engaged in financial fraud, as compared to the older employees. They also found out that, the higher the position of an employee, the bigger the theft they committed. Hollinger and Clark identified another correlation between job satisfaction and workplace deviance. These found out that employees that were dissatisfied were more likely to break rules, irrespective of their age or job position. Therefore, opportunity is not a reason why employees commit fraud, but motivation. This therefore, points to the aspect of “wages in kind.” When an individual feels that they are being treated unfairly or inadequately salaried, they are at a greater risk of looking for alternative ways of balancing the inequalities, as their sense of self-worth directs them (Hollinger & Clark, 1983). Nonetheless, from this theory, it might be concluded that, employee-thieves exhibit deviance at the workplace. Additionally, employers learn that they should be sensitive to employee needs, especially their compensation. The second theory of fraud is the classic fraud theory, which is based on the aspect of financial pressure (Albrecht, Albrecht & Dolan, 2007). The criminologist Donald, R. Cressey interviewed about 200 embezzlers that were incarcerated, and these also included convicted executives. Findings from the interviews revealed that the individuals committed the frauds in order address the pressure to meet their financial needs. Cressey identified three major factors, which he considered important, and had to be present for individuals to commit fraud. These include opportunity, rationalization, and pressure. First, individuals must identify an opportunity, which will enable them to commit and conceal a specific fraud. Secondly, individuals must be able to rationalize the fraud, and not regard it as a crime. Finally, before committing fraud, a fraudster will experience pressure, including financial and non-financial pressures (Albrecht, Albrecht & Dolan, 2007). This is shown in the fraud triangle below. Figure 1: The Fraud Triangle Source: Albrecht, Albrecht & Dolan (2007) These two theories offer important insights into the reasons why employees commit fraud. Although these address separate factors of motivation to commit fraud, all are applicable to financial fraud. Therefore, the factors of motivation and opportunity are all key in determining whether an employee will commit a fraud or not. Nonetheless, these also offer important insights to auditors, on how they can detect fraud effectively. Form this; an auditor learns that it is inappropriate to rely on books alone, when detecting frauds. Instead, one should consider events happening outside the books. Hence, an auditor should look out for financially depressed employees, as these might be potential fraudsters. This research topic is highly relevant in international finance today. Therefore, different companies, including financial institutions will highly benefit from this research. For instance, financial fraud, including fraudulent financial reporting results in the loss of trust of investors in the involved company (Dooley, 2002). The investors will stop investing, and might terminate any pending financial contract, as they consider the company untrustworthy. According to Albrecht, Albrecht & Dolan (2007), when a company is involved in fraudulent reporting, the market value of the company’s stock experiences a considerable decrease, and at times, as much as 500 times the amount of the fraud. Additionally, when a company files for bankruptcy, people who have shares in the company are hurt financially. Therefore, through this research, companies learn the importance of investor trust, without which they might experience higher capital costs, which is detrimental to them. Therefore, it is important for companies to conduct their businesses with the highest level of ethics, which is important in attracting investors, and enabling the company to function efficiently. Future Directions This research has not addressed all the elements that are important in understanding financial fraud, and its impact on national economies. Therefore, future research on this topic should address these. First, there is need to provide examples of the companies, which have a history of fraudulent financial reporting, and identify the specific resultant detrimental effects. This is important, as it would make the research to draw on real examples, thereby bringing out fraud as a real problem, which different countries are facing. Further research on this topic should also address the current measures different countries have adopted in the fight against financial fraud. This is necessary to show how these standards have failed, and what might be done to strengthen them to fight effectively against financial frauds. In addition, this will help to show the seriousness with which most countries regard financial fraud. Furthermore, future research on this topic should explore how technology and globalization contribute to financial fraud. This is the era of information, where technology use is advanced. Therefore, it is important to identify how technology contributes to major issues today. In this case, further research should deeply explore the influence of the internet on financial fraud. This will therefore, help to explore financial fraud in the context of the 21st Century. This research has addressed the issue of financial fraud, thereby adding to its publicization. This is an essential issue in the financial sector, because of the different impacts it has on the affected institutions and economies. Therefore, by increasing awareness of financial fraud through research and reporting, this makes more people to identify financial fraud as an aspect that has significant effects on the economy, as well as the quality of life. By using different theories, this research has shown some of the ways through which companies and auditors can prevent or detect fraud. Therefore, successful application of the propositions in these theories might help to lower incidences of financial fraud. In future research of international research, this theoretical background might be important in helping policymakers in international financial markets to devise effective strategies of addressing the issue. Overall, this will enhance the field of international finance. Conclusion Financial frauds are detrimental to individuals, institutions, governments, and the overall economy, including national and international economies. The number of financial frauds does not matter, since even one financial fraud might have detrimental effects, especially if it is a big and audacious fraud. Overall, financial frauds damage investor trust in an institution, including their reliability on financial statements. Although the number of financial frauds identified over a period of time might be relatively small, these result in enormous economic losses. These economic losses of the concerned individual institutions are also felt by the national economies of the affected institutions. This also translates to negative impact on the global economy. For this reason, financial fraud is an important issue, which needs to be addressed to ensure an effective national and international economy. Therefore, there is need for the implementation of strategies that will help to effectively prevent, detect, or expose financial frauds. This is important, as it will help in the restoration of confidence and trust in financial reporting, which is core to capital markets. References Albrecht, C., Albrecht, C. C., & Dolan, S. (2007). Financial fraud: The how and why. European Business Forum, 34-39. Retrieved from http://search.proquest.com/docview/224666213?accountid=45049 Boerner, H. (2009). Global capital markets and corporate compliance reforms ahead: The G-20 tackle the issues. Corporate Finance Review, 13(4), 33–< /font>36. Retrieved from the ABI/INFORM Global database Das, D. (1993). International Finance: Contemporary Issues. New York: Routledge. Dooley, D. V. (2002). Financial fraud: Accounting theory and practice. Fordham Journal of Corporate & Financial Law, 8, S53-S88. Retrieved from http://search.proquest.com/docview/89064698?accountid=45049 Eichengreen, B. (2009). 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