DFC |1

DRAFT For discussion purposes only

Do not quote or reproduce without the authors permission.
A Disposition-Based Fraud Model: Theoretical Integration and Research
Agenda
Vasant Raval
(vraval@creighton.edu)
Heider College of Business
Creighton University

ABSTRACT
For several decades, most discussion on financial fraud has centered on the fraud
triangle, which has evolved over time through various extensions and
reinterpretations. While this has served the profession well, a void exists in the
identification of the human side of the act. This research is dedicated to developing
a model to explain the role of human desires, intentions, and actions in indulgence
of, or resistance to, the act of financial fraud. Evidence from religion, philosophy,
sociology, and social psychology is integrated to identify and support a new fraud
model, called the disposition-based fraud cycle (DFC). To articulate the model, its
two primary components, disposition and temptation, are further developed and
extended. Although generally applicable any act of fraud, the paper primarily
focuses on the executive fraud. The similarities and differences between the DFC
and theory of planned behavior, fraud triangle, and Hunt and Vitell model are
discussed. Additionally, some of the previously undecipherable mysteries of
financial fraud are interpreted using the DFC model, suggestions for further
research are offered, and the DFCs strengths and limitations are noted.
Keywords: Financial fraud, disposition, temptation, ego depletion, self-efficacy,
executive fraud
INTRODUCTION
Much of our current understanding of why perpetrators commit fraud is grounded in
the Fraud Trianlge (hereafter, FT) (Dorminey et al, 2010). Undoubtedly, the FT
seems to have served moderately well in a fight to tame financial fraud (Hogan et
al, 2008). The FTs presence in the auditing pronouncements (see AICPA, AU 316)
signals its importance in controlling financial fraud. Given its permanence, several
revisions to the FT have been proposed over time. For example, Albrecht et al
(1984) advocate replacing rationalizations with a more observable construct,
personal integrity, measured using what they call a fraud scale. Wolfe and
Hermanson (2004) proposed that the triangle might better serve financial fraud

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prevention and detection if it were turned into a diamond, with the actors capability
as the fourth condition. Choo and Tan (2007) appended the Broken Trust Theory
introduced by Albrecht et al (2004) and an American Dream theory to the FT with
a view to extend its explanatory power. Dorminey et al (2012) speak of MICE
(Money, Ideology, Coercion, and Ego (entitlement)), an idea under discussion in
recent years, that could offer a way to assess the actors motivation to commit
fraud a question that the FT does not fully address.
Understandably, we likely would focus on what has made reasonable sense in
deciphering our past experiences. However, vigilance requires that we heed
Kahneman (2011, pp. 277-290): once you have accepted a theory and used it as a
tool in your thinking, it is extraordinarily difficult to notice its flaws. If you come
upon an observation that does not seem to fit the model, you assume that there
must be a perfectly good explanation that you are somehow missing (p.277). So,
not unlike patch management in the software industry, we have seen a number of
updates, modifications, and extensions around the FT in the spirit of creating
perfectly good explanations of what the original FT cant explain. The familiar is so
difficult to give up, to make room for a new thought (Kuhn, 1962). This is a powerful
motivation for this study: to search for a fraud model that is holistic and potentially
more effective.
Undoubtedly, a great deal of research on fraud risk factors has been accomplished
in recent years, and many of these studies have sprouted independent of the FT.
However, if researchers attempted to anchor their results to some theoretical
paradigm, with some exceptions, their choice was almost always the FT. In the
absence of a viable alternative model, interpretations from rather rigorous research
attempts would likely be somewhat limited or may not even surface on the radar.
Furthermore, the absence of an alternative that could supplant the FTs weaknesses
could limit research in propositions that dont anchor well on the FT. In turn, this
may have limited our insights from the research efforts and may even have
constrained free thinking on possibilities of fraud risk factors beyond the bounded
space provided within the triangle. In sympathy with what is lacking, we often hear
that any fraud is, after all, a human act (Ramamoorti, 2008). However, in the
absence of articulation of the process behind the act, the message seems to lose its
appeal over time.
This study views financial fraud from a different perspective: the human disposition
grounded in virtue ethics. In an earlier exploratory effort, Raval (2013a) searched
for an alternative to the FT. Leaning on the teachings of Eastern metaphysics, he
(2013b) identified key parameters of the model which he named the Dispositionbased Fraud Cycle (hereafter, DFC), an open-system framework that separates the
actor from the act itself and accounts for the interaction between the actor and the
circumstances of the act. It identifies the true nature of the actor and traces the
possibilities of an act of fraud in a separate cycle. This paper clarifies the DFC model
and presents related empirical evidence.

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Whereas the DFC is generally applicable, our attempt here is to focus on the chief
executive for various reasons. First, the SEC continues to name senior management
in its enforcement releases for some level of involvement in fraud, with the
CEO/CFO named in almost all cases1 (Beasley et al, 2010). Second, the failure of
leadership to self-regulate often translates into devastating impact on the
companys stakeholders. If an organization is vulnerable to material fraud, chances
are it is the leadership of the organization that plays a role in the episode. 2 The
COSO 1998-2007 Report (Beasley et al, 2010, p. 2) notes that the high level of
involvement of top management has important implications for the control
environment. Finally, the upper echelon perspective (Hambrick and Mason, 1984)
suggests that organizational outcomes are reflections of the values and cognitive
bases of powerful actors in the organization. Without limiting the DFC, we therefore
focus on a particular group of actors, the executive leadership.
The organization of this paper is as follows. We begin with a brief summary of the FT
and review selected studies on financial fraud using the theory of planned behavior
(TPB). Next, we describe the DFC. And where possible, we provide support for the
model, drawing on past studies in various fields. Importantly, we draw from the
model unique fraud risk factors, reinforce some existing ones, and deemphasize
others. Finally, we discuss limitations of the DFC and offer suggestions for new
directions in financial fraud research.
THE FRAUD TRIANGLE AND ITS EXTENSIONS
Cressey (1953) hypothesized that for an act of fraud to occur, each of three criteria
must be present: 1) the actor experiences a non-shareable financial problem
(pressure), 2) the actor has an opportunity to violate a position of trust
(opportunity), and 3) the actor is able to adjust his self-perception such that he
believes such a violation does not constitute criminal behavior (rationalization).
Taking roots in the findings of Cresseys work (1953), the FT emerged: the presence
of the three conditions indicate the possibility of a financial fraud. Over time, the FT
has been somewhat modified and extended (see Dorminey et al, 2012) as a
reaction to perceived deficiencies of the original FT. 3
1 Table 5 of the report (p. 14) shows that an overwhelming majority was composed
of senior management, including vice-president, controller, CEO, CFO, and CEO/CFO.
2 This notion is supported by the studies suggesting tone at the top as a key fraud
risk factor (see, e.g., Apostolou et al, 2001).
3 For example, it is proposed that the condition, rationalization, should be replaced by
integrity (Albrecht et al, 1984) and Dorminey and colleagues (2010, p. 21) warn that sources
of pressure may include other than personal financial need.

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A fundamental weakness of the FT is that the attributes of the actor and
circumstances under which the act occurs are not separately identified. The three
conditions of the triangle do not logically lead to the process involved. Thus, a mere
transactional view of such indiscretions limits our holistic understanding of the act.
The FT does not explain why under certain conditions a fraudulent act may not
occur, or why a fraudster could resist the indulgence under different circumstances.
Or, under identical conditions in two firms, why one executive commits fraud, while
the other resists it. The whole universe of non-actors executives who did not and
may not commit fraud is not considered in the FT. The alternative proposed here
promises the explanatory power to address such unanswered questions.
THE THEORY OF PLANNED BEHAVIOR (TPB)
One of the leading contenders among the behavioral models with potential
explanatory power in financial fraud cases is the Theory of Planned Behavior
(hereafter, TPB) introduced by Ajzen (1991) and his colleagues (Fishbein and Ajzen,
1975). An integrated model of behavior, the TPB a more comprehensive
consideration of the Theory of Reasoned Action is not a fraud model as such;
however, its purpose is to explain any planned, or intentioned, action. Since
fraudulent acts are essentially planned behaviors contingent upon the will of the
actor, the TPB framework is relevant in financial fraud research.
The TPB exclusively concerns volitional actions of individuals, involving an intention
to act (or not act) in a particular context. Four variables interact to influence the
decision: attitude, subjective norms, perceived behavioral control, and moral
obligation. A persons attitude toward the behavior is a measure of the persons
evaluation of behavior as good or bad, following a consideration by the person
of both behavioral beliefs and outcomes evaluation. A subjective norm concerns the
individuals general social pressure to perform (or not to perform) the behavior.
Perceived behavioral control is a measure of the persons ability to perform the
behavior, based on their past experience, competence, and any obstacles they may
face. Moral obligation refers to a duty or obligation a persons moral belief system
triggers as the right thing to do.
Numerous empirical studies, many of which are unrelated to the question of
financial fraud, have attempted to experiment with the TPB. This heightened
examination over more than 30 years has further resulted in several meta-analysis
efforts (Randall and Wolff, 1994; Sheeran and Orbell, 1998; Armitage and Conner,
2001). In a quantitative integration and review of research encompassing 185
studies, Armitage and Conner (2001) found that the TPB accounted for 27% and
39% of the variance in behavior and intention, respectively. The perceived
behavioral control (PBC) construct accounted for significant amount of variance in
intention and behavior. Attitude, subjective norm, and the PBC account for
significantly more of the variance in individuals desires than intentions, but
intention was a better predictor of behavior, while the subjective norm was found to

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be a weak predictor of intentions. The latter observation, the authors believe, is
partly attributable to a combination of poor measurement and the need for
expansion of the normative component.
Several studies have focused on an application of the TPB to the financial fraud
puzzle. Carpenter and Reimers (2005) conducted a survey, followed by an
experimental design to study the relevance of the TPB in the context of fraudulent
financial reporting by managers. They examined the effects of attitude, subjective
norm, and PBC on a mangers decision to improperly defer the recognition of
expenses so that the company can meet an earnings target. The results suggest
that attitude and subjective norm both have significant influence on prediction of
behavioral intent, while the PBC did not contribute much to this influence. The
authors surmise that this last result may have to do with the nature of the sample
and possible lack of relevant experience of the subjects. They assert that the results
of the two studies provide strong evidence that the TPB can help explain ethical
decision making by business managers.
Recognizing the potential of the TPB in explaining financial fraud as a human act,
Cohen et al (2010) sought to implant the TPB dimensions in the FT. They amplified
the rationalization condition of the FT with the four specific dimensions of the TPB:
attitude (toward fraud), subjective norms, perceived behavioral control (PBC), and
moral obligation. They searched for evidence from U.S. press coverage contained in
the Factiva database regarding the reported 39 corporate fraud cases. Using
content analysis, they identified frequencies of the two FT conditions
(incentive/pressures, opportunities) and the four TPB elements (which replaced the
rationalization condition) in media coverage through content analysis of the articles.
Tracking the presence of each element in media coverage, they revealed that with
the exception of subjective norms, frequencies were present for each of the
elements. The component, subjective norms, is less prevalent in the press, probably
because it is more difficult to identify, even with the hindsight perspective of
journalists (Cohen et al, 2010, p. 285). The authors traced these frequencies to the
auditing pronouncements and thus suggested several additional fraud risk factors
not currently considered in the auditing pronouncements.
In sum, the limitations of the FT are evident and research to enhance our
understanding of financial reporting fraud has received attention. It seems,
however, that a patchwork approach to remodel the FT is constrained by the initial
visualization of the fraud triangle. A fresh look at the nature of financial fraud with
particular attention to the human side is warranted.
DISPOSITION-BASED FRAUD CYCLE (DFC)
Behavioral outcomes are inevitably a function of a complex interaction between
organism and environment (Bem and Funder, 1978, pp. 485-486). Therefore, a
complete model of human behavior has to include two interacting elements:

DFC |6
organism (agent) and environment (context4). An agents behavior is expressed as a
series of occurrences; each occurrence is a representation of a specific interaction
of the organism with specific environmental conditions. Whereas the agents traits
change little over time, the context of each act is different, causing variety in
episodes of the actors behavior. Since fraud is a deliberate behavioral outcome, its
explanation involves both organism and its environment. To quote Willem Bonger
(1905): As always it is the environment that is the cause of the crimes taking place;
it is the individual differences which explain in part who is the one to commit them
(p. 137).
The fundamental premise upon which the DFC is built is roughly as follows: People
commit fraud by indulging in a moral temptation leading to an intentional act; since
people are dispositionally different, some are more likely to indulge in such
temptation while others may be able to resist it. Disposition belongs to the
organism, while temptations that lure people are constantly emerging in the
environment. In our discussion of the DFC model, we begin with the environment
where stimuli for temptation come into view, then proceed to discuss individual
differences in the form of human disposition. We reiterate: the DFC model is
applicable to any kind of fraudulent act, although our focus in this paper is entirely
on the powerful corporate executives. The DFC model in its most basic form is
shown in Figure 1.
Figure 1. The Primary Elements of the DFC

TEMPTATION
Temptation has been studied over centuries in various disciplines, including religion
(St. Ignatius, 1548), philosophy (Holton, 2009; Bratman, 1987; Hume, 2000),
sociology and social psychology (Bandura, 2002; Baumeister, 1996), and health
care (Trope and Fishback, 2000). In the New Testament, the word temptation has
been used to convey meanings such as to test, examine, or put on trial. 5 Temptation
forces one to evaluate volitional choices. Falling prey to temptation involves
compromising the future for something potentially less valuable or even harmful,
but can be indulged into at the very moment. Temptations carry a sense of
immediacy; they have a short shelf-life for you to entertain them (Raval, 2013b).
4 Context is also indicated by the usage of terms such as Maya or Matrix.
5 According to New Testament, temptation approaches human beings in diverse
ways and tries to motivate them to follow the voice of egoism, anxiety, strive for
power and profit, instead of listening to what is according to conscience.

DFC |7
And the indulgence releases a whole range of emotional responses. It is what you
crave,6 independent of what and how much you have. Kozlowski, the former Tyco
CEO, had enough, yet he succumbed.
Temptation has to do with volitional exercise of ones intentions. Holton (2009)
considers ones resolutions as a class of intentions, and suggests that yielding to
temptation involves an unreasonable revision of a resolve in the face of pressures
from contrary inclinations.
The process of being tempted into an indulgence takes several sub-steps. Although
the number and description of these steps vary across sources, the general pattern
of how temptation works is well established. The Gita (2.62-2.63, 3.06) discusses
the general sequence in the degradation and downfall of a person (Easwaran, 1988,
pp. 123-128; Tilak, 2004, p. 903):
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)

One contemplates on the objects of senses.

Intimacy with the objects of senses grows with continued contemplation.
Intimacy intensifies the desire to possess the object of senses.
The person becomes obsessed to possess the object of senses.
Obstructions, if any, in the way of fulfilling this desire elicit anger and aversion.
Bewilderment overtakes the agent.
As a result, the person fails to distinguish right from wrong.
The person succumbs to the temptation. A compromise of ones resolve materializes.

In his discussion of volitional actions (freedom of the will) or choice, Holton (2009, p.
57) invokes a normative four-stage model that typically characterizes the exercise
of choice:
1.
2.
3.
4.

Deliberating: Considering the options that are available, and their likely consequences.
Judging: Deciding that a certain action is best, given the considerations raised in the process of
deliberation. Judging results in a belief.
Choosing: Deciding to do the action. Choosing results in an intention.
Acting: Doing that thing and coordinating other actions and intentions around it.

Holton (2009) further clarifies (p. 67-68) that forming an intention can sometimes
seem more like a rolling ball finding its equilibrium settling point, than like the
tripping of a switch. Even though the choice is something of which we are
conscious, the mechanism by which we arrive at it can involve a drawn-out process
of which we are not aware.7
A first step in the sequence is contemplation on some object of desire. 8 The object
itself can be intangible, such as the desire to overstate income (e.g., WorldCom) or
6 According to Kennett (2001, p. 57), the craving provides a context in which the
less desirable object becomes more attractive without the benefit of any supporting
change in the beliefs.
7 If asked, would the executives who have committed financial fraud be able to
articulate the process they followed to come to their intentional act? Perhaps not.

DFC |8
manipulate reported earnings in line with the analysts expectations (e.g., Enron).
Littman (2010, p. 35) asserts that power and drive are responsible for temptations
to commit fraud, and modern executives possess both in abundance. The powerful
and passionate executive gets attached to certain expected results of performance
(e.g., ratios that meet covenants). As the executive traverses through the stages of
attachment, this attachment grows from contemplation to intimacy, to
intensification, and finally to obsession. The obsessed executives attachment to the
unpossessed object exerts a magnet-like force, with a got-to-have-it attitude. If
the executive is weak willed,9 he succumbs to the temptation as the connection
between Reason (buddhi) and Will temporarily fades, permitting the clouded
judgment to prevail.
A promising antidote for temptation is self-regulation. If everyone was effective in
self-regulation, temptations would probably have little effect on private and work
life. Self-regulation, often called self-control, represents ones capacity to regulate
oneself. Baumeister, Heatherton, and Tice (1994, p. 7) define self-regulation as any
effort by a human being to alter its own response, which may include actions,
thoughts, feelings, desires, and performances. Self-regulation relies on a feedback
loop composed of standards, monitoring, and corrective response. In the absence of
standards, it would be difficult to determine what is expected. Once a standard is
set, one needs to self-monitor the current state and determine its divergence, if any,
from the standard. Any divergence calls for the need to regulate; that is, override
responses that drift the person away from the standard.
A hierarchy of multiple processes at higher and lower levels is involved in selfregulation (Carver and Scheier, 1981, 1982). Higher processes involve longer time
spans, more extensive networks of meaningful associations and interpretations, and
more distal or abstract goals (Baumeister et al, 1994, p.8). Self-regulation means
the override of lower processes (e.g., impulse to smoke a cigarette) by the higher
processes (e.g., the resolution to quit smoking), which is termed transcendence. For
the executive, the higher process dictates staying firm with the moral resolve (e.g.,
not to cook the books) but the lower process reminds of immediate consequences
(e.g., increase in interest rate on loans due to a breach of loan covenant).
Transcendence can only happen when higher processes carry enough strength to
override lower processes. When such override fails, self-regulation fails; one might
say that in such cases, the person yields to temptation. Indulgence can be

8 To quote Holton (2009, p. 102): desire pulls me to a course of action: that I have
an urge, or, in more extreme cases, a craving, something that moves me to do it. .
. . Desire in the sense we are after is a state that preoccupies an agents
attention with an urge to perform a certain action.
9 Weakness of will is one of several reasons why people yield to temptation.

DFC |9
interpreted as ones failure to self-stop; that is, failure to intervene in ones
response pattern in order to bring it to a halt.
Acts of fraud can be interpreted as failure to stop, allowing lower processes to take
charge, thus yielding to temptation on hand. An act of fraud is an engagement with
a temptation to deceive; deception in financial reporting fraud may occur through
misrepresentation of information or misappropriation of assets. The fiduciary
responsibility of the fraudster is thus compromised and the trust of the principal is
violated.
With so much at stake in the life of a corporation, a powerful executive at the helm
is trusted to do the right thing. In the context of the agency theory, the agent can
be held responsible to self-regulate in the matters of business conduct. Particularly,
yielding to moral temptation compromises the executives integrity. Executive
frauds could lead to failure of the organization, sometimes with grave consequences
to its stakeholders (see Littman, 2010, for examples of executive fraud). The ACFE
Report to the Nation (2012) finds that perpetrators with higher levels of authority
tend to cause much larger losses. Whereas antidotes can be implemented to detect
or prevent fraud at lower levels in the organization, it is widely recognized that
there are not many effective measures available to guard the guardian. 10 If they
fail, the company they lead fails.
Moral Temptation
Temptation can be perceived as non-moral (eating candy instead of carrots) or
moral (stealing instead of buying). Holton (2009) argues that one would expect
revisions to some resolutions, while others are expected to remain firm. Moral
intentions are a special kind of intentions; they should not be subject to
reconsideration. If revised in light of contrary inclinations, it simply means that the
agents resolve is gone, that she likely would yield to the temptation on hand. A
series of reasonable revisions to a non-moral resolve (e.g., wavering in a decision to
pick a restaurant for dinner) may not be of any significance, though it may prove
the person capricious. On the other hand, a revision to the executives resolve to
protect the assets of the company is unreasonable and compromising, signaling a
breakdown in agency.
Human nature is such that acts of indiscretion occur, and when they occur, they
point to the persons moral reasoning. To quote Prescott (1847): Where there is no
free agency, there can be no morality. Where there is no temptation, there can be
little claim to virtue. And as Samuel Richardson puts it, we can all be good when
we have no temptation or provocation to the contrary. 11 Temptations test resolve;
moral temptations test moral resolve. Brinkmann (2005, p. 183) describes moral
temptation as an objective action opportunity that turns up, which is subjectively
10 This phrase is quoted from Littman (2010, p. 34).

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perceived as attractive and which presents a test of an individuals (or perhaps
groups) morality, or more specifically of ones character, ones principles, or ones
will. Executive financial fraud is a breakdown in agency due to the executives
failure to hold on to the moral resolve.
A moral resolve reflects the persons virtue; a moral temptation represents
circumstances leading to the possible occurrence of a compromise, that is, an
ethical dilemma. Holtons definition of indulgence an unreasonable revision of a
resolve in favor of contrary inclinations is inclusive; it suggests that in some cases,
the resolve that is revised has a moral dimension. Moreover, moral temptations
clearly involve agency and therefore, trust of the principal. Presumably, the sphere
of immediate influence of non-moral indulgence may be limited to the persons
private life, while moral compromises may have a broader influence. 12
Intentional Action
Bratman (1987) argues that when an agent forms an intention, he resolves to
perform the action, either by an explicit conscious process or some less deliberate
process. In either case, the resolution, if not reconsidered, leads to action that aligns
with the resolution now and in the future. Once formed, intentions have a tendency
to persist, providing stability to ones actions. This state of stability is relative, not
absolute, for at times, there may be perfectly valid grounds for the agent to revise
his intentions. The state of stability and the consequent persistence of the agents
intention provides for efficiency in information processing, for well-formed intentions
will not require reconsideration and, therefore, possible revisions in the future. Thus,
having intentions is helpful in terms of control and stability. From a psychologicalphysiological perspective, temptation to break ones resolve emerges when the
agent has a choice of immediate rewards that compete with longer-term gains. At
this stage, the person (1) is successful in avoiding the temptation, or (2) succumbs
to it and indulges in the immediate gratification of rewards. One who indulgences
essentially goes through a shift in the perception of what is best: immediate
rewards or long-term gains.
Judgment shift
Judgment shift occurs when the agent abandons her resolve in favor of immediate
rewards. As a result, the evaluation of choices on hand becomes biased in favor of
breaking the resolve. In almost all cases of temptation, giving in to the urge is
caused by the judgment shift (Holton, 2009). A judgment shift is necessary in
11 Whereas we cite a broad spectrum of studies on non-moral temptation in our
discussion, the DFC exclusively focuses on moral temptation.
12 In the long run, the society may be affected. For example, smoking may lead to
cancer, and may therefore cause financial and non-financial burdens on the society.

D F C | 11
situations of ordinary temptation (as distinguished from addiction-like temptation,
discussed later) where the agent at the time of indulging undervalues the preferred
option. To overcome cognitive dissonance triggered by the judgment shift, the agent
formulates rationalizations to justify the act resulting from the temptation.
Karniol and Miller (1983) conducted an experiment on judgment shift with eight
year-old children. The children were shown marshmallows and chewing gum (and
these were then left in the childrens plain sight) and asked for their preference. Half
the children are then told that they can have their first choice, but only after the
experimenter returns from some tasks that she has to do. The other half are
provided additional instruction: at any point they can ring a bell to summon the
experimenter, in which case they will get their second choice. The experimenter
returns after 10 minutes and declares that she is not yet in a position to give the
rewards, but she forgot to ask a question earlier: On a scale of one to five, what
value would you put on the two options? Interestingly, the group with a choice to
ring the bell gave a significantly lower value to their preferred choice compared to
the group that did not have the chance to ring the bell. The valuations of those who
had no chance to ring the bell are the same as those of the control group who did
not have to wait.
According to Holton (2009, p. 102), this undermining of the preferred choice
(judgment shift) takes place as follows: (1) the tempted children find their attention
focused on the immediately available sweet; (2) consequently, to get it right away,
they have a strong urge to ring the bell; (3) as they become aware that they are
likely to succumb to this urge, they change the evaluation of their options to avoid
cognitive dissonance. Thus, cognitive dissonance and the resulting rationalizations
are side effects, not active drivers of fraud.
A dominant reason for the judgment shift is the weakness of will, a failure to hold on
to ones moral intentions and thus, a failure of self-regulation. The weakness of will,
however temporary, creates a window where the person is likely to falter. What is
good for the person in the long term becomes minor in deciding whether to indulge.
In Kennetts (2001, p. 57) words: The craving frames the options in such a way that
in its grip the individual focuses on the loss involved in giving up the immediate
state rather than the gains in the terminal state. . . . [T]here is evidence that
losses in the intermediate state are weighted more heavily than the gains in the
terminal state.13 Temptation feels like a bargain (Luke 4:1-13). What happens
ultimately may not occur to the actor as either significant or relevant; what matters
most at the time is the experience offered by the temptation (Raval, 2013a, p. 11).
Citing a number of studies, Trope and Fishbach (2000, p. 504) confirm: (immediate)
temptations often prevent people from sticking to their long-term preferences.
13 Kennett (2001) argues that the yielding to an urge results when motivating
reasons outpace normative reasons.

D F C | 12
While specific instances of judgment shift in executive fraud may vary, a generic
rationalization driving the shift could be in the spirit of saving the corporation in
the short run. This may be in the form of, for example, patching up ratios for
meeting covenants, or overstating revenues to report revenues in line with investor
expectations. The thought that might tip the scale toward breaking the resolve
would probably rest on the notion that if this is not done, the corporation may face
an uphill battle (higher costs, lower share prices, etc.) in its survival.
In sum, judgment shift drives the closure on an act of being tempted into
indulgence. It is the fundamental transformation in the process of evaluation.
Neither the immediately available reward nor the long-term gain has changed; only
the evaluation of options becomes biased, resulting in the breakdown of resolve and
a failure of transcendence.
Addiction-like Temptation
Repeated offenses are more like the behavior of addicts. Addiction-like breakdown in
moral resolve is like yielding to the temptation repeatedly over time. In a case of
ordinary temptation, the agent who yields to temptation may never again repeat
the indulgence; however, this is unlikely in most cases. Commonly, self-regulation
failure may gradually snowball; the crucial thing is for the failure to get started, and
regaining and reasserting self-control will become progressively more difficult
(Baumeister et al, 1994). Beaumeister et al (1994) call this phenomenon
psychological inertia: the longer someone is doing something, the more difficult it
may be for that person to stop.
Psychological inertia was vividly present the Satyam Computers fraud. In a letter to
the Board, the CEO noted the following:
The gap in the balance sheet has arisen purely on account of inflated profits over a period of
last several years. . . What started as a marginal gap between actual operating profit and
the one reflected in the books of accounts continued to grow over the years. . . . Every
attempt made to eliminate the gap failed. . . . It was like riding a tiger, not knowing how to
get off without being eaten.14

Beasley and his colleagues (2010, p. 17) report that fraud periods extended on
average for 31.4 months, and many of the frauds began with misstatements of
interim financial statements that were continued in annual financial statement
filings. This cycle of quarterly reporting followed by annual filing could involve
repeated frauds of the same kind; instances that follow the first fraud seem to fit
the description of addiction-like temptations giving into the psychological inertia.

14 See http://timesofindia.indiatimes.com/business/india-business/Full-text-of-Rajusresignation-letter-to-the-Board/articleshow/3946538.cms?referral=PM, accessed

May 5, 2014.

D F C | 13
In moral breakdowns, addiction-like cases should be differentiated from ordinary
temptations. In the case of ordinary temptation, a comparison of immediate and
long-term rewards may neutralize the temptation. In contrast, subsequent to the
initial incursion, addicts no longer compare the immediate gains with long-term
benefits (Holton, 2009). Thus, the addictive behavior can persist even when the
person is convinced of the disparity in outcomes. While weakness of will plays a role
in yielding to ordinary temptation, it bears little significance in the case of a
repeated offense, for it has already actualized once. Thus, a judgment shift is less
likely to occur in addiction-like temptation. While ordinary temptation is marked by
the collaboration of wanting and liking, addiction-like temptation persists on only
the wanting, even if the agent dislikes subsequent indulgences. As a consequence,
addicts may succumb to temptation by just thinking that resistance is impossible.
SELF-REGULATION FAILURES
The locus of self-regulation failure is somewhere along the loop: standard setting
and awareness of what the standards are, self-monitoring of the divergence of
actual states from the standard, and taking corrective action (i.e., self-stopping from
indulgence). In the absence of standards, there is no self-regulation possible. If
there are multiple standards and they are conflicting (e.g., companys code of ethics
does not resonate with the executives inner beliefs), confusion takes over and the
exercise in self-regulation may be futile. A discrepant, conflicting internal set of
standards leads to muddled, indecisive, unsure, and rebellious responses, confusion
about identity, and emotional stress (Van Hook and Higgins, 1988). Children in an
experiment effectively obeyed instructions that prohibited a certain behavior, even
weeks after the instructions were given. However, if the two experimental authority
figures disagreed about the rules, the children were not likely to conform to their
instructions (Maphet and Miller, 1988).
A lack of standards, or the presence of conflicting standards, is vividly present in the
Ponzi schemes. In a fraud of this type, everything from a beginning to the height of
its manipulation is maneuvered by a single executive, drawing upon the self-efficacy
that is built on reliance on a few trusted persons that the actor recruits in the
process of building the organization. The actor in a Ponzi scheme never has a moral
resolve; sheer desire to want more at any cost drives his actions. Hence, this type of
fraud fits the addiction-like failure of self-regulation; there is total absence of
judgment shift, the schemer has decided well before the beginning of the
enterprise that this is what he will do.
Where standards exist, the agent may fail to self-regulate because she forgets
about them, thus lowering the threshold of attention paid to the standards.
Renegade attention poses a significant risk because managing attention is likely the
most generally effective technique of self-regulation (Kirschenbaum, 1987). Since it
is more effective to avoid temptation than to resist it, attention to the standards and
constant awareness of stimuli are important in the prevention of self-regulation

D F C | 14
failures. Myrseth and Fishbach (2009) conducted a series of experiments on
temptations and related rewards. Their studies suggest a two-stage model of how a
tempted person might overcome the temptation. A first stage is that the person is
aware that the dilemma exists. We believe the awareness is rooted in ones
disposition which mirrors his or her moral stage development. People with high
moral stage development are more likely to be aware of conflict and therefore, can
potentially stand firm on their moral resolve.
Self-regulation Failures and Psychological Inertia
When self-regulation occurs, higher processes prevail over lower processes; the
immediate urge is stopped in favor of the resolution. Self-stopping is perhaps the
easiest way to self-regulate. To a degree, successful self-regulation depends on the
timing of the response. The psychological inertia progressively sets in as the agent
moves from contemplation to intimacy, to intensification, and to obsession; it
becomes harder along the way to stop running into indulgence. The sooner the
control action is taken, the greater the likelihood of self-regulation success. The
founder of the Jesuits, St. Ignatius of Loyola, writes in his widely known Spiritual
Exercises: I resist [an evil thought] promptly and it is overcome; the second I resist
it, it recurs again and again and I keep on resisting until the thought goes away
defeated.
The difficulty in self-stopping results from psychological inertia (Baumeister et al,
1994): an agent already in the midst of an indulgence will have great difficulty in
withdrawing from it what is in motion cannot be easily stopped. Psychological
inertia is not new; the widely known Zeigarnik effect suggests that a response
sequence in progress is difficult to interrupt. And in most religious scriptures,
exercise of moderation is advised to inhibit ones advance into progressively deeper
stages of failure in regulation (see, for example, The Gita, 4:26).15 One reason why a
person may not be able to avoid temptation (or stop it in its early stages) is called
ego depletion, which we discuss next.
Self-Regulation Failures and Ego depletion
Stanowich and West (2008) researched how the mind engages itself in making
volitional choices. They identified two separate systems, involved in the process:
System 1, which works on automated tasks, and System 2, which is engaged when
attention is required in processing information to arrive at the choice. System 1 is
intuitive and lazy, while System 2 is effort-intensive. Most routine tasks (e.g., adding
two numbers) are undertaken by System 1; System 2 does the heavy-duty work
(e.g., driving on a crowded street in Mumbai) where attention is required and
information processing is complex.
15 Buddha described the discipline of moderation as madhyamarg, which translates
as the middle road.

D F C | 15
Kahneman (2011, p. 41) asserts that self-control and deliberate thought (cognitive
effort) are the forms of mental work of System 2. People who are concurrently
challenged by a demanding cognitive task and by a temptation are more likely to
yield to the temptation. Because System 2 is busy with the demanding task, System
1 takes over the processing of tempting stimuli. System 1 has more influence on
behavior when System 2 is busy, and has a tendency to indulge.
Baumeister and his colleagues (1998) have proved that voluntary effort in any form
cognitive, emotional, or physical draws on the mental energy. An effort of will, or
self-control, is tiring. They describe the phenomenon, called ego depletion: a
demanding effort of self-control leaves one with less to effectively cope with the
next challenge.16 To quote Kahneman (2011, pp. 42-43), [A]ctivities that impose
high demands on System 2 require self-control, and the exertion of self-control is
depleting and unpleasant. . . . After exerting self-control in one task, you do not
feel like making an effort in another. . . Intuitive errors are much more frequent
among ego-depleted people.
A general phenomenon operating in various contexts, ego depletion also applies to
temptation-related behaviors. The CEO of an automaker in the midst of a recall of a
few million cars at work or cathartic divorce proceedings at home would likely have
much less left to stay focused on the higher processes, and this could result in a
compromise on moral grounds. Recently, KPMG senior partner Scott London
admitted that he passed tips to a golfing buddy about KPMG clients. He notes that
even though he knew it was wrong, he thinks some element of burnout may have
impaired his judgment, which in turn resulted in the compromise. 17 Undoubtedly,
ego depletion does not justify a breakdown in moral resolve, although it may result
in rationalization of the act.
The state of inadequate strength due to depletion of mental and/or physical energy
is usually temporary and varies over time, depending on the challenges or
relatively quiet periods the person faces over time. Fighting the strains of a deep
recession or serious regulatory actions would suggest low strength (high depletion),
while a booming economy and favorable trends of the business could result in little
depletion in the executive. This could explain why in rough economic times in the
life of a company, executive financial fraud may be more noticeable than in times of
prosperity. Ego depletion may or may not be involved in causing the judgment shift,
but it provides a possible pre-condition for temptation to override the persons
resolve; it facilitates the temptation to succeed and in this sense, it explains why
16 The use of the term ego in ego depletion is not clear. Ego in Sanskrit equates to
Aham, or pride, which is a dispositional property of Swabhava, or ones character.
17 Prison-Bound KPMG Ex-Partner Remorseful for Insider Tips, M. Rapoport, The Wall
Street Journal, June 26, 2014, C3.

D F C | 16
ordinary, decent, capable people sometimes fall prey to temptations. According to
the 2012 ACFE Report to the Nation, approximately 87% of occupational fraudsters
had never been charged or convicted of a fraud-related offense, and 84% had never
been punished or terminated by an employer for fraud-related conduct.
Self-regulation failures Addiction-like temptations
If ordinary temptation is difficult to avoid, addiction-like temptation is even harder
to overcome. In fact, addiction-like temptation begins with an already failed state, a
condition that makes rebounding of the person to the state of transcendence
(preferring higher processes over lower ones) an uphill climb. Due to the lapse that
has already occurred, cases of compromise that follow could snowball into larger
violations over time. This drifting of the person has been explained as abstinence
violation effects (with particular reference to impulse control). Following the lapse in
ones resolve, the person feels like going on a binge. Lapse-activated, or
snowballing, failures occur due to various reasons, including zero-tolerance beliefs,
emotional reaction to the initial lapse, and a reduction of monitoring (Baumeister et
al, 1994). A zero-tolerance for breakdowns in resolve would lead to strong frontline
safeguards, but once these are broken, there is no further diligence imposed.
Breaking the barriers, however well-guarded, could lead to the feeling that the
resolve is no longer relevant. It is also likely that the person would lower the
threshold on seeking feedback of further divergence, if any, since the breakdown
has already been accepted.
In sum, abstinence violation effects could potentially explain addiction-like failures.
As discussed previously, such failures are illustrative of psychological inertia. In
repeated failures of the same kind over time, it is unlikely that ego depletion would
explain the act, for it may be rare to find consistently same levels of ego depletion
at the time of each occurrence.
SELF-EFFICACY
In a breakdown of resolve suggesting compromise of trust, the indulgence is
entertained in a well-calculated manner. A prospective actor would not want to yield
to a temptation knowing that the indulgence would be exposed, resulting in severe
negative consequences for him and possibly for the organization he leads.
Therefore, the actor evaluates whether the indulgence on hand can be materialized
without any hindrances, and if its anticipated after-effects can be managed.
The notion of feasibility evaluation in light of ones capacity involves a careful
consideration of anticipated obstacles that may come in the way of indulgence. In
financial fraud, the agent most likely identifies and evaluates specific controls that
could hinder the indulgence on hand and considers possible ways including
collusion and overrides in which to negate the effect of such controls. A series of
actions to commit, conceal, and convert will require an understanding of people and

D F C | 17
procedures that could present roadblocks and how these might be coped with in a
fraud.
Corporate frauds often require more capacity than a top executive alone possesses.
We therefore suggest a broader view of self-efficacy, where collusion at the top level
might be necessary to commit the fraud and hide it from others. Specifically, the
executive may enroll members of the top management team to collaborate in the
act of fraud. Bernard Madoffs decade-long Ponzi scheme warranted a vast array of
technical, accounting, and marketing skills; to harness these, he recruited and
controlled the continued loyalty of five of his staff members in addition to the CFO. 18
In the Satyam Computers case, the CEO resorted to a comprehensive manipulation
of financial accounting information. Over time, even employee count, payroll,
customer accounts, and cost of sales were manipulated to lend apparent validity to
the financial misrepresentation. This would require an in-depth understanding of the
financial accounting system; to get these results, knowledge of and access to
accounting systems was necessary, and override of top-level financial accounting
controls was required. For this, he induced his CFO to join him in the act. 19 At Enron,
Jeffrey Skilling and Andrew Fastow united to produce an unprecedented financial
fraud.
Finally, several constructs overlap with self-efficacy. Particularly, Setiyas (2007, p.
99-106) concept of instrumentalism and its derivative, means-ends efficiency, and
Perceived Behavioral Control identified in the TPB are similar in nature. And the idea
of embedding capability as an additional condition in the fraud triangle (Wolfe and
Hermanson, 2004) signifies the need for inclusion of some variation of self-efficacy
in an explanatory fraud model.
Obstacles

18 In a verdict issued in the Federal Court in Manhattan, the jury found five former
employees guilty of collaborating with Bernard Madoff in his Ponzi scheme: two
computer programmers (Jerome OHara and George Perez), two portfolio managers
(Annette Bongiorno and JoAnn Crupi), and operations director Daniel Bonventre.
(Jury Finds Staff Aided Madoff Con, The Wall Street Journal, Tuesday, March 25,
2014, A1-2).
19 This trend seems pervasive in financial reporting fraud. During the period 19982007, the SEC named CEO and/or CFO in 89 percent of fraud cases for some level of
involvement in financial fraud (Beasley et al, 2010).

D F C | 18
We define obstacles20 as any position or procedure that may ruin the experience
of indulgence at any stage of the act, which may last an undetermined period of
time. Relevant obstacles affect self-efficacy and thereby prevent or detect financial
fraud. During the tenure of a compromise, roadblocks may come up; the
prospective actor has to identify and evaluate the feasibility of overcoming these
obstructions. The most recognized obstructions within a company are the internal
controls, viewed as antidotes for opportunities. For example, an internal control
related to work roles concerns segregation of duties between the CEO and the CFO,
and an internal control related to procedures is the requirement of certification by
the CFO and the CEO concerning the effectiveness of their companys control
system.
Temptations are stimuli that may (1) relate to specific existing opportunities or (2)
prompt the agent to create new opportunities to suit the temptation on hand. Since
only the relevant controls can be effective obstacles, a control framework that casts
a wide net to catch almost anything imaginable is likely to be inefficient. On the flip
side, because a specific temptation might not be present in the generic set of
opportunities, the temptation may not face a relevant obstacle. The design of
internal control systems based on an anticipated universe of opportunities may
result in redundancy and yet, may fail to catch the act of indulgence.
Obstacles include more than a narrowly defined set of internal controls. For
example, they may include change in the behavior of the collaborator in the
scheme, or an incident report on the whistleblower system. We need a much wider
definition of obstructions beyond just internal controls anchored to address
recognized opportunities based on a better understanding of self-efficacy and how
the actor might maneuver it. An investment in opportunity-neutral controls, such as
a whistleblower system, can have across-the-board applicability and organizationwide reach to become more effective. Clearly, additional research is needed to fully
grasp differences between opportunities as generally understood, and temptations.
Finally, an important distinction should be made between foreseeable obstacles at
the time of the act and any subsequent developments, or post hoc obstacles. If the
act of indulgence needs continuing cover up, at the time of indulgence it would be
necessary for the actor to identify any new obstacles and determine how to deal
with them. Post hoc obstacles may not have been anticipated by the agent and may
in fact be troublesome or impossible to deal with. Assuming the executive
possesses a high degree of self-efficacy to launch the fraud, what may reveal the
act ultimately would likely be a trigger from post hoc obstacles. Presumably, the
executive pondering a temptation would also subject post hoc obstacles to a new
round of self-efficacy tests as and when they surface. Besides learning about the
nature of such obstacles, it would be of interest to study the feasibility of
20 We use the terms obstacle and obstruction interchangeably since both indicate a
disruptive outcome.

D F C | 19
implementing controls that would disclose such obstacles to those in charge of
governance sooner rather than later following the fraud.
In most experiments of temptation, there usually is limited or no manipulation of
obstacles. Consequently, very little is known about how obstacles actually work in
acts of indulgence, or how self-efficacy is operationalized to thwart relevant
obstacles. In financial fraud research, the examination of temptation as a trigger
has been rare.
A PARTIAL VIEW OF THE DFC
Thus far, we have focused on temptation and variables that may cause the
temptation to succeed in an intentional action to commit a breach of moral resolve.
Additionally, we discussed the role of obstacles pre- and post-compromise and the
significance of self-efficacy (to the agent) in deciding to commit the indiscretion.
Figure 2 presents a partial view of the key variables and their relationship. 21
Figure 2. A partial view of the DFC

Resisting Moral Temptation

Our interest is more in finding how powerful executives could resist rather than yield
to an unreasonable inclination to break the resolve. An understanding of the
dispositional bent of the resistors could provide unique insights on how they cope
with moral temptations, skipping the whole cycle of misdeeds. Once identified, such
traits may prove valuable in devising relevant and effective antidotes to the act of
fraud.
21 Although the model does not explicitly incorporate emotional responses of the actor, it
should be acknowledged that such responses would surface across the entire process, from
consideration to break the resolve, to indulgence, to post hoc consequences of yielding to
the urge. Emotional responses include guilt, shame, anger, fear, frustration, and rage any
of these could occur at different stages in the cycle. A detailed analysis of emotional
responses in the DFC model is beyond the scope of this paper.

D F C | 20
One way to resist temptation is to disregard it altogether. In well-known writings
called Spiritual Exercises, St. Ignatius of Loyola shares the following:
There are two ways of gaining merit when an evil thought comes from outside. . . . I resist it
promptly and it is overcome. . . . [or] I resist it, [but] it recurs again and again and I keep
on resisting until the thought goes away defeated. One sins venially when one . . . gives
ear to it, . . . or when there is some negligence in rejecting this thought. 22

If instead of rejecting the evil thoughts, one continues to brood over the desire for
unpossessed objects (e.g., corporate earnings in line with guidance), one
undoubtedly obtains it, fictitiously if not factually, in the case of financial reporting
fraud. When brooding over evil thoughts persists, invariably the result is that these
thoughts get executed.23 And yet, while withdrawal from the stimuli is one option, it
is perhaps quite difficult for many due to the psychological inertia.
A person may be able to resist temptation if his mind is aligned to what he can
control or impact. For example, the chief executive may be able to control the
organizations strategy and its execution. But he may not have total control over
actual gross margins or profits, for these are subject to vagaries of markets and
macroeconomic changes in the business environment. Even the most effective and
well-executed strategy may not produce desired results, even if everything under
the executives control is done correctly. Recognizing that effort is within and
outcomes are beyond ones influence is likely to stop the executive from chasing a
mirage. According to the The Gita (3.47):
A persons authority extends only to the performance of action; obtaining or not-obtaining the
result is never within the persons authority or control. Therefore, do not be the one who
performs action with the (avaricious) motive (in the mind) that a particular result should be
obtained of ones action.

The belief that you have control over outcomes is wrong. You must do everything
that your talents and capacities allow you to do to achieve the results; however, you
should remain unattached to the outcomes. The renowned ethicist T. H. Green
(1906, p. 367) echoes the same idea:
If indeed the question . . . could leave me under the impression that in doing so and so I was
all that I should have been, it would be important for me to be reminded that the action may
have had evil consequences which I did not foresee but which yet are a part of my act. . .
[M]oral function of my act is fully served without supplementary enquiry into unforeseen
consequences of the conduct.

The outcomes we typically attribute to the leader are clearly influenced by many
exogenous factors. In the case of a CEO, for example, the financial outcomes are
affected by economic factors, competition, political uncertainty, or regulatory
changes. Since the CEO does not control many of these significant influences on his
22 Ignatius of Loyola, Spiritual Exercises, 1548, p. 291.
23 Patel (2000, Stanza 44, p. 27).

D F C | 21
companys financial performance, he should be constantly aware of this and should
act only to exert the best possible effort. And while doing so, recognize fully that the
results may be quite different than the company guidelines or analyst expectations.
This sort of non-attachment to outcomes while fully committing to the efforts is
what the CEO and her team can do best. The CEO behavior guided by such mindset
would likely help her resist, for example, the temptation of doctoring financial
results. Unfortunately, emphasis on getting the numbers expected by the securities
market is built into the CEOs performance measurement; efforts to achieve the
performance count very little. But the reality seems even worse. As Jennings (2006,
p. 17) observes, there is not just a focus on numbers and results, but an
unreasonable and unrealistic obsession with meeting quantitative goals.
Since a judgment shift plays a key role in the indulgence, it would be of interest to
investigate how the judgment shift occurs in an act of fraud and how an executive
could better resist the temptation. For example, for a judgment shift to occur, the
tempted person has to value the long-term gains (e.g., value of restricted stock
units awarded over time) less than the immediate rewards (e.g., loss of current
compensation due to losing job for poor performance). Is it likely that if the
magnitude of difference between the immediate and long-term rewards is
significant, the judgment shift would probably not occur, for it will be difficult to
justify in ones own mind (rationalize) that the immediate gains are more attractive
on balance than the long-term gains?
Regulation Internal and External
As already discussed, one and perhaps the ideal approach is to rely on the
executive to self-regulate. Today, it seems that lawmakers, enforcement agencies,
and auditors consider it a foregone conclusion that it is the failure to self-regulate
that we need to contain, not the comfort in how well top executives regulate
themselves. Apparently, the idea that self-regulation works is already discarded.
And the thought of allowing self-regulation to govern is presumably lacking
acceptance amongst the concerned professions and regulatory forces close to the
problem of executive fraud.
If regulation does not happen from within, the option is governance through an
ecosystem comprised of antidotes, monitoring and rewarding the executive, and
exerting force of external regulation. This external system of antidotes to expected
fraud risks may sound holistic; however, several limitations remain. The governance
measures from outside almost exclusively deal with the environment and not the
organism. Yes, there is some talk about the executives lifestyle, ego, and such
other dispositional variables, but the role of such attributes does not seem
convincing, is rather soft in nature, and has not been central to the existing
governance ecosystems. This may be due in part to implementation issues inherent
in such an approach. It is much easier to defend, for example, how controls would
limit the fraudster from seeking opportunities. However, the evidence in this regard

D F C | 22
is not always converging. Smith, Tiras, and Vichitlekarn (2000) studied whether the
strength of internal controls is inversely related to the propensity of a manager to
commit fraud. Using an auditors allocation of efforts between control testing and
substantive testing, they found that the likelihood of detecting the fraud does not
increase when the auditor exerts effort to assess controls.
Any ecosystem built from concrete past experience relies on our understanding of
the history of financial fraud, thus limiting what we choose to build into the
ecosystem.24 The solutions proposed often reflect political stance, or may be based
on limited prior fraud evidence. So the value of the governance web in preventing or
detecting fraud remains suspect. For example, despite elaborate provisions for
control and disclosure of related-party transactions (RPT), Gordon and colleagues
(2007) report that RPT does not appear to increase auditor risk assessments,
although it is one of the top reasons cited for audit failure when a fraud does occur.
In a sample of 261 firms, Bonner and colleagues (1998) found that 20 percent of
their sample had fraud issues that concerned RPTs. According to the COSO Report
(Beasley et al, 2010, p. 33), 79 percent of fraud firms disclosed RPTs compared to 71
percent of no-fraud firms (p=0.065); however, that difference was not statistically
significant in either of the two sub-periods (1991-99 and 2001-04) examined. For
the RPTs in which top leadership is involved (founder, CEO, other senior officers, and
board members), for each group, there was no difference between fraud and nofraud firms. The signals from RPT governance measures are mixed and it seems this
effortful oversight has low payoff in fraud prevention or detection.
Current ecosystems of governance also stress heavily the role of audit and
compensation committees. But the recent COSO Report (Beasley et al, 2010)
observes the following: Relatively few differences existed in the characteristics of
audit committees and compensation committees between fraud and no-fraud firms.
This is not to say that governance from outside has no role to play. The real
challenge comes from incorporation in the design of governance structures the
vulnerability of the human side. To bridge this void, we lean on the idea of selfregulation and further elaborate on human virtue expressed through human
disposition. We propose two major categories of disposition and discuss their
characteristics. Finally, we identify the role of dispositional properties in the urge to
yield to, or resist, moral temptations.
DISPOSITION OF THE EXECUTIVE
A moral action is volitional and is a result of character interacting with
circumstances; it is the expression of a persons character as it reacts upon and
responds to given circumstances (Green, 1906, p. 120). As Green (1906, p. 176)
24 The problem is similar to what the Transportation Security Administration (TSA) in the United
States is facing. The screening processes built primarily on the knowledge of existing violations leave
the system vulnerable to yet unexplored tricks to beat the system.

D F C | 23
asserts, there are two distinct objects of moral approbation or disapprobation:
intentional action and motive or character of an agent. Motive indicates a good or
bad habitual disposition a bent of character from which useful or hurtful actions
are likely to arise (p. 176). Green further articulates that any life the individual can
possibly live is at best limited by the necessities of his position. The position in life
in turn determines the moral capacity, actualized through habits.
Since virtues are traits of character, [the virtue theory of practical reason] is more
readily framed in terms of our dispositions to engage in a practical thought (Setiya,
2007, p.8). Philosophers and theologians have studied human disposition for
millennia (see, for example, Hume, 200025).26 Among the researchers, Ryle (1949)
has analyzed more fully the nature and role of disposition. Discussion of virtues (and
vices) and their relationship with the constituent elements of a persons nature
called disposition is evident across religions. The Gita, about 3,500 years in
existence, shows the way of living (Radhakrishnan, 1979), a model that transcends
millennia of human history with constancy of eternal truth. Throughout its text, the
Gita heavily integrates the role of human disposition in the quality of ones life. It
extensively discusses in various contexts the three gunas (enlightened, passionate,
and indolent), also called inner nature or essential character (svabhava), and how
their presence in different degrees makes the person dispositionally different from
others. This is shraddha (faith) that drives a person to pursuits of his choice. In
Aurobindos words (1996, p. 492): The souls faith, not mere intellectual belief, but
its concordant will to know, to see, to believe and to do and be according to its
vision and knowledge is that which determines . . . the measure of our
possibilities of becoming.
It is important to differentiate between disposition and an occurrence. Ryle (1949, p.
124) contends that our proneness, or bent, to act in certain ways is stable and
predictable such that we could regard it as an inference ticket. A CEOs lifestyle,
for example, mirrors her disposition and thus offers potential to work as an
inference ticket. However, while a certain lifestyle may suggest proneness to
indulgence, it by no means proves that every CEO with the given lifestyle would
invariably indulge in improper behavior. To quote Ryle (1949, p. 116):
To say that a person knows something . . . is not to say that he is at a particular moment in
process of doing or undergoing anything, but that he is able to do certain things, when the
need arises, or that he is prone to do and feel certain things in situations of certain sorts.

Ryle further explains the difference between disposition (e.g., glass is brittle) and
occurrence (if the glass ever is struck, it would fly into fragments); the disposition
(brittleness) materializes into an actual happening (shattered glass). Green (1906,
25 Hume first published The Treatise of Human Nature during 1730s.
26 For a discussion of disposition and its relationship with morality, see Raval (2013a).

D F C | 24
p. 174) articulates disposition and occurrence as the will in possibility and the
will in actuality, respectively.
A persons disposition translates into motivation for desires of different kinds
depending on the predominance of one of the three gunas: sattvik, rajsik, and
tamsik. Thus, a person is considered (1) sattvik or enlightened (passionate and
possesses existential knowledge of right from wrong (hereafter, P(E)); (2) rajsik or
passionate and ignorant (active, but does not possess existential knowledge of right
from wrong (hereafter, P(I)); or (3) tamsik or indolent, who possesses neither
passion nor knowledge.
Tamsik, Rajsik, and Sattvik dispositions are also described as nescient, subcoscient,
and coscient, respectively. Nescient disposition indicates inertia of knowledge and of
action. A person of this disposition does not know right from wrong and suffers from
inaction. In contrast, people of both subscient and coscient disposition are full of
energy and drive. One thing they have in common is the desire for action; however,
the difference between the two is as follows. The passionate being, P(I), is ignorant
of right action; thus, he is vulnerable to express and implement desires that are
morally unsound. In contrast, enlightened individuals, P(E)s, express high levels of
moral grounding, being aware of distinctions between what is right and wrong, and
therefore are likely to act according to their moral compass.
Although all three gunas are present in every being, ones disposition is influenced
by the most dominant guna in a person. We focus on the first two, P(E) and P(I), 27
since both include the presence of passion, which is a required characteristic of
chief executives; indolent people with little or no passion are rarely found to be
viable business leaders, for they lack intensity to pursue any kind of action. 28
Ones disposition (svabhava) and duty (svadharma) are interrelated. Any talk of
virtue without reference to moral obligation is indeed meaningless. What we see as
our duty is in large part a matter of inner conscience, inner qualities that define our
disposition, based on the degree of presence of gunas. Since disposition is reflected
in ones behavior whether it is at the physical, mental, or moral level it also
represents the moral stage development of the person; that is, the moral fabric of a
person is invariably tied to his disposition. Consequently, disposition and duty are
coincident in the sense that a persons character mirrors his moral grounding.
Taking six stages of moral development (Kohlberg, 1984), we surmise that the
27 The classification, R(s) and R(t), in Raval (2013a) is simplified here as P(E) and P(I), respectively,
for ease of communication and recall.

28 Interestingly, other religions also point to the role of disposition. For example, Rumi (Baldock, 2006,
pp. 164-167) suggests this classification: Angels, Descendents of Adam, and Beasts, roughly
comparable to the enlightened, passionate, and indolent disposition, respectively, deeply rooted in the
Gitas teachings.

D F C | 25
lowest three (social norms, self-interest orientation, and obedience and punishment
orientation) align with P(I)s and the highest three (law and order morality, social
contract orientation, and universal ethical principles), with P(E)s. 29 This binary
classification is comparable to Greens (1906, p. 377) descriptions of those with
unwholesome preoccupation with self and those with eagerness in disinterested
service, respectively. Table 1 summarizes the characteristics of the three gunas and
related expressed behaviors.
Table 1. Characteristics of the three gunas
Disposition
type

Basic description

Notatio
n
used

Existential
knowledge
(moral
stage
developme
nt)
NO

Motivat
ion for
desire
(passio
n)

Rajsik
(Subcoscie
nt)

NO

YES

P(I)

Sattvik
(Coscient)

YES

YES

P(E)

Tamsik
(Nescient)

NO

Expressed
Behavior

Negligent, error-prone, slothful,

inattentive, dull, inactive, lack
goal or direction.
Liking and longing, desire for
unpossessed satisfaction, passion
to seek whatever appeals to
them, unrestful, feverish, excited

Goodness, seeking lasting

happiness, contentment,
harmonious

Kohlbergs moral
stage
identification

Obedience and
punishment
orientation to
compliance; selfinterest; social
norms.
Law and order
morality; social
contract
orientation;
universal ethical
principles.

The presence of moral dimension in human disposition suggests that, while there
can be brute force means available to achieve the end, it may not be the most
virtuous path to success. And yet, it can be the chosen path for some. As Setiya
(2007, p. 3) suggests, one need not have the virtues of character in order to be
good at getting what one wants. And if one is selfish but efficient, the virtues . . .
may seem to get in the way. In our classification of disposition, P(I)s stand on a low
moral ground; they tend to be selfish or self-regarding, and are vulnerable to take
shortcuts. P(E)s stand on a high moral ground; they are other-regarding and are

29 For a detailed discussion, see Raval (2013a), p. 5-6.

D F C | 26
unlikely to indulge in indiscretion. Green (1906, p. 379) articulates the difference
very well: A true Moral Philosophy does not recognize any value in a universal rule,
simply as such, but only in . . . the readiness to sacrifice every lower inclination to
do the right for the sake of doing it. The followers of only the rules are more likely
P(I)s, and those who take the high road are P(E)s.
The profound thinker and scholar of Hinduism, Aurobindo (1996, pp. 460-490)
describes P(I)s as the human representation of the titans and P(E)s as the gods.
According to him, the normal man is ordinarily a mixture, but one or the other
tendency is more pronounced, which tends to make him predominantly rajasotamsik [the titans] or sattvo-rajsik [the gods] and can be said to be preparing him
for either culmination: for the titanic turbulence, or divine clarity, respectively. The
titans are ostentatious, possessing characteristics of egoistic greatness, satisfaction
of desire (attachment),30 and indulgence. Driven by desire and ego, they are
arrogant, full of self-esteem, and proud. Misguided, they persist in false and
obstinate aims and pursue impure resolution of their longings. They imagine that
desire and enjoyment are all the aim of life. And they seek to impose on the world
their personality for their own pride, glory, and pleasure. In contrast, the human
representation of the gods reflects temperance, humility, knowledge and
awareness, self-control, beneficence, and perfection. 31
While being passionate about the goal is an absolute must for a successful business
leader, its downside is that the executive is vulnerable to making errors in judgment
when he faces moral temptation. Because they are enlightened, P(E)s in all
likelihood are safe from committing indiscretion, while P(I)s, passionate in action but
morally weak, are vulnerable and might break their resolve. Note, however, that any
vulnerability does not automatically transpire into an act.
Beginning with early efforts of Parameswaran (1969), various researchers have
attempted to design and validate psychometric inventory to measure disposition
(Das, 1987; Pathak et al, 1992; Marutham et al, 1998; Stempel et al, 2006;
Matthew, 2010). Dasa (1999) refined the Vedic Personality Inventory of disposition
and tested the validity of the constructs using several convergent and construct
validity measures. Collectively, these attempts show that disposition as a variable
has potential for use in validating the DFC.

30 The Gita (4:26) says the following: Rajas is passion, bleeding selfish desire and attachment. These
bind the person to compulsive action.

31 Aurobindo (1996, p. 471) is aware of the limitations of this classification. He states that [t]he
distinction . . . is not comprehensive of all humanity, not rigidly applicable to all individuals, neither
is it sharp and definite in all stages of moral or spiritual history of the race or in all phases of the
individual evolution.

D F C | 27
Whereas such measures of disposition could lead to significant insights in laboratory
experiments with other subjects, there are two distinct concerns regarding their use
with executives. First, the executives are likely to resort to impression management;
consequently, valid data may not be obtained. Second, top corporate executives are
busy and may not respond, which could result in a low response rate. There are,
however, indirect or derived measures that may work as surrogates. The media
coverage of the executive is one potential source to identify patterns of the
executive disposition. Also, those who have significant exposure to the executive
(e.g., directors, external auditors, analysts) may be able to provide unique insights
into the executives disposition. Raval (2013c) analyzed the nature of disposition
from the philanthropies of executives of U.S. corporations who had committed
financial fraud during the period 1992-2005. He found sufficient data only on the
executives philanthropy in one case, on the disposition of the executive in 21
cases, and both on philanthropy and disposition in the remaining 11 cases. Given
the limited data, he formed two tentative conclusions: Based on broad behavioral
descriptions of their traits, most executives in the sample exhibited the P(I)
disposition; an analysis of the occurrences of philanthropies from a dispositional
viewpoint showed that in all 11 cases (about 52%) the nature of executive
philanthropy confirmed P(I) disposition of the executive.
In summary, passionate executives are an epitome of business success. An
organization thrives on their drive and energy. However, among them, those on the
weaker moral ground (P(I)s) are likely to fall prey to temptations; and those on a
stronger footing (P(E)s) are unlikely to act in a fraudulent manner. Morality stems
from character, and ones character is reflected in ones disposition. The motivation
for desire, triggered by ones disposition, is seeded in the inner qualities of the
individual. For a fraud to occur, it provides a basis for possibilities, it is a necessary
condition; however, by itself, it is not sufficient to determine whether an act of fraud
would actually occur. It only provides a strong and necessary signal regarding the
executives vulnerability to fraudulent behavior.
Willpower
The concept of will appears to be magical, ethereal, and abstract. Citing dozens of
studies, Baumeister and Tierney (2011) discuss at length the concept of willpower
and its various behavioral implications. In its simplest description, willpower is
strength, more like a muscle, that disciplines the mind to follow ones resolve. It is,
in a sense, the energy of a being to control the mind, not to waiver and shift, but
rather to stay committed to ones resolve. It is thus a means of thought control that
regulates ones intentional actions. Strong willpower would permit one to sustain
higher order processes; weak will is vulnerable to degrade intentional actions to
lower order processes.
Much like other energies, willpower can be deployed under various conditions (e.g.,
in test-taking or obeying a rule). Baumeister and Tierney (2011, pp. 16-17) identify

D F C | 28
four broad categories of uses of willpower: the control of thoughts, control of
emotions (e.g., trying to escape from bad moods), impulse control (e.g., resisting
temptation), and performance control (e.g., managing time). Much like an overused
muscle, willpower can be subject to fatigue, described as ego depletion; the more
you use it, the more likely you have less of it, at least temporarily. People in a state
of depleted willpower are likely to make judgment errors.
Willpower is the backbone of self-regulation, a character trait essential to building a
good life. It can be viewed as a collection of habits, bents, and proneness to behave
in certain ways, and these are all expressions of human disposition. Consequently,
human disposition is likely related to willpower. Willpower can be improved over
time through consistent use of appropriate exercises of body, mind, and spirit. It is
likely, for example, that those CEOs who follow strict regimen of yoga exercises will
not suffer from low strength of willpower. Whereas habits, proneness, and bents
cannot be changed overnight, they are malleable and can be worked on for
improvement over a period of time.
It appears that willpower cannot be defined, exemplified, or described without the
bedrock of disposition. It is from the disposition of a person that strength of will
emerges. For example, as self-regarding individuals attached to worldly desires,
P(I)s are vulnerable to compulsive action. They are likely more involved in proximal
goals and find the link between proximal and distal goals rather tenuous. When not
bridged to distal goals, proximal goals could lead to moral failures. This is because
the agent might perceive immediate rewards as more attractive. On the other hand,
P(E)s, having knowledge of action and also knowledge of purpose in life, are more
likely to develop a strong bridge between proximal and distal goals. This in turn
could lead to fewer moral failures among them.
In his analysis of weakness versus strength of will, Holton (2009) identifies three
factors interacting in the process of resisting (or yielding to) temptation: The
strength of willpower, degree of articulation of the resolution, and motivation to
abide by the resolution.
A.

The strength of willpower can be built up by a rigorous regimen of exercise; however,

willpower at any given moment is affected by ego depletion, which needs to be considered
in cases of temptations. Depleted willpower does not necessarily mean the person would
indulge, for the strength of motivation to stick with the resolve may permit resistance even
when weakness of will exists.
B. With respect to articulation of ones resolve, Holton suggests that many moral
commitments are general policies. Explicit resolutions are not necessary for successful
resistance of a moral resolve; they may have been arrived at through a slow process of
education; some could even be innate. We believe innate formation of resolutions has to
do with ones disposition: P(I)s are on a morally weak ground in this regard, while P(E)s
have high moral standards. Thus, the interpretation of broad policies could be practically
rule-based (Am I breaking the law?) rather than principles-based (Is this right thing to do?).
C. The motivation to abide by the resolution is in many ways the first critical signal. The
strength of motivation to fight the conflicting desires is clearly at play in temptation
scenarios. We believe this strength is directly related to ones disposition. P(E)s with high

D F C | 29
moral stage development are in a much better shape in terms of moral strength than the
P(I)s.

Having discussed all of the key variables involved in the DFC, we now introduce the
complete model in Figure 3. The hard lines connect the core of the model; the
dotted lines show the relationship with associated variables that surface as a
consequence of, or as a driver of, the core process.
Figure 3. A complete view of the DFC

Comparison with Other Models

Hunt and Vitell (1986) proposed a general framework model suggesting that
environmental factors (cultural, industrial, and organizational) interact with personal
experiences, thus forming ones perception of the existence of an ethical problem,
alternatives, and consequences. Through deontological and teleological evaluations,
these result in ethical judgments operational in the development of intentions. The
intentions interact with situational variables to produce behavior, which leads to
consequences and adds to ones personal experiences. Common to both Hunt and
Vitell model and the DFC are: The recognition of environmental variables, the
person-environment interaction in ethical problem solving, and the interaction
between intentions and situational constraints (which we believe is comparable to
self-efficacy). However, there are significant differences in perspective. For example,
the role of human disposition and temptation, two components in the DFC, is not
explicitly incorporated in the Hunt and Vitell model.
The DFC model incorporates some of the characteristics of the FT; for example, it
includes rationalizations, albeit only as outcomes of indulgence (rather than as a
condition for fraud to occur), and preserves the role of obstacles, which are
somewhat comparable to internal controls. The variable attitude often seen as a
replacement for the rationalization condition in the FT, is absent in the DFC. Instead,

D F C | 30
the inclusion of human disposition is logically well founded in the DFC. The DFC
exhibits much greater clarity, for it posits that integrity stems from disposition, selfefficacy incorporates the consideration by the fraudster whether he will actually be
able to pull it off, and rationalizations are outcomes of indulgence. The DFC
describes the interactions between nature and disposition explicitly. Importantly,
one-time occurrences and repeated offenses are explained by the model, and the
drama of Ponzi schemes, which elude professionals and regulators, is now framed in
proper context in this model. The model intuitively shows why executives who
commit fraud have no prior record of any violations or any need for more wealth.
Greed as an explanation has unfortunately muddied the discussion in the past;
the DFC model does not incorporate greed as a driver of financial fraud. 32 And it
explicitly accounts for not just the actors, but also non-actors of fraud.
The theory of planned behavior (TPB) puts forth the relationship between intention
and behavior. The TPB originally incorporated three variables: The agents favorable
or unfavorable evaluation (or appraisal) of the behavior under consideration
(attitude), perceived influence of significant others on the agent (subjective norms),
and the agents perceived ability to perform the behavior (perceived behavioral
control (PBC)). Beck and Ajzen (1991) in their study of dishonest actions added a
variable: the responsibility to perform (or resist) a certain behavior (moral
obligation). In the DFC model, the variable attitude does not appear as a separate
variable, nor is there any role of subjective norms. The PBC is comparable to selfefficacy (Ajzen, 1991, p. 184). And moral obligation in the DFC model is implicit in
resolutions those intentions that should remain firm and unchanging. An important
distinction is that in the DFC model, disposition and moral obligation are an integral
part of the process of occurrences of (or resistance to) dishonest action. It seems
that the variable attitude as defined in the TBP model is only partially related to the
variable disposition in the DFC model. In a study to examine whether PBC can be
empirically distinguished from self-efficacy, Manstead and Van Eekelen (1998) found
that behavior was predicted better by self-efficacy than by intentions, and
intentions were more closely related to self-efficacy than to attitudes, subjective
norms, or PBC.
P(I) Disposition and Narcissistic Personality
P(I) disposition is passion, breeding selfish desire and attachment, which bind the
person to attachment (The Gita, 14:7). The Gita further declares that selfish desire
is to be found at all levels in the senses, mind, and intellect, misleading them and
burying the understanding in delusion (4:40). In fact, the entire Chapter 4 in The
Gita is devoted to selfless service and its significance in defining lifes mission a
path that P(E)s are better suited to take. Throughout The Gita, P(I)s have been
described as ostentatious, outward, and self-centric. The ostentatious nature of P(I)
32 An argument can be made, however, that greed drives the perception of shortterm rewards as more attractive than long-term gains.

D F C | 31
is surprisingly similar to the key characteristics of narcissistic personality. DuBrin
(2012, pp. 11-15) discusses behavioral symptoms of people with a high standing on
the trait of narcissism: self-admiration, statement of superiority, incessant talking,
interrupting others, temper tantrums, expectation of special attention, dependence
on others for reinforcement of the self-image, perfectionism and compulsivity, and
limited empathy. People with narcissistic personality are not necessarily selfish;
however their focus is still on the self. In the narcissism checklist of 25 items, DuBrin
(2012, p. 10) includes the following: Believes that he or she can accomplish
anything with proper effort. Thus, the sense of entitlement to outcomes a
tendency that leads people into breaking their resolve is ingrained in narcissistic
personality.
The notion of how individuals perceive, comprehend, and interpret the behavior of
others toward themselves is known as self-construal. The research on self-construal
suggests that the content and structure of the inner self may differ considerably
between persons, depending on their view of the self and the relationship between
the self and others (Markus and Kitayama, 1991). Since human disposition is in
some ways a representation of the inner self, it would seem that self-construal is
related to the binary classification of P(I) and P(E), where the former is focused on
oneself and the latter, on the collective. Extending the concept of self-construal to
ethical leadership, Gils et al (2010) suggest the following relationship: the focus on
the individual (self) is consistent with pre-conventional level in Kohlbergs moral
stage development, and the focus on the collective, with post-conventional level. In
the DFC model, the same parallels exist: P(I)s are self-centric while P(E)s are othercentric. P(E)s are potentially better suited for fiduciary responsibility of serving the
stakeholders of a company.
Studies show that narcissism is related to white-collar crime (Blickle et al, 2006).
Addressing narcissistic tendencies in an audit environment, Johnson et al (2013)
studied managerial narcissism as an indicator of fraud attitude. In a client-(audit)
manager context, they found that narcissism was significantly associated with a
measure of engagement fraud risk, suggesting client narcissism as a diagnostic
indicator of client integrity and ethics.
Specifically addressing the CEO behavior, Chatterjee and Hambrick (2007)
conducted an insightful study of 111 CEOs. They found support for all four
hypotheses: The greater the narcissistic tendencies of a CEO, (1) the greater the
dynamism of the company, (2) the greater the number and size of acquisitions
made by the company, (3) the more extreme the companys performance, and (4)
the greater the fluctuation in the companys performance. More recently, using
survey data collected from 173 CEOs, Wales et al (2013) investigated firm-level
entrepreneurial orientation as a strategic mechanism that narcissistic CEOs may
leverage to influence changes in organizational performance. They found that
narcissistic CEOs have a propensity to increase entrepreneurial orientation (EO) in
the organizations they lead, and EO partially mediates the relationship between

D F C | 32
CEO narcissism and firm performance variance. Both studies (Chatterjee and
Hambrick, 2007; and Wales et al, 2013) relate to the DFC model in the following
ways. The pursuit of aggressive entrepreneurship (including firm dynamism and
number of acquisitions) combined with volatility in firm performance can cause
frequent ego depletion of the CEO, for the attention necessary to lead the firm will
constantly present unusual challenges. The ego depletion combined with focus on
outcomes not just efforts could lead to breakdown in the CEOs moral resolve.
In sum, P(I) disposition overlaps with narcissism. Both narcissistic and P(I)
executives are ostentatious, focused on self-glory and final outcomes, and both are
vulnerable to a breakdown in their moral resolve. The DFC places the narcissistic
leadership orientation in a larger context, especially in relation to vulnerability to
moral temptations, and how this vulnerability could actualize in the form of a
financial fraud.
IMPLICATIONS
In this section, we discuss executive fraud risks evident in the DFC model. We
emphasize already-identified risk factors relevant to the model, and introduce new
risk factors emerging from the DFC. In the process, we argue why certain risk
factors will have a limited role in executive financial fraud. Our discussion follows
the two broad components of the model: environment and disposition. We only offer
broad observations in this section; a selected research agenda stemming from the
DFC is included in Table 2, where we summarize our curiosities only in the form of
general statements, not rigorous hypotheses.
Looking at the existing control frameworks, almost exclusively the environment is
the focus of control. Attitudes and rationalizations are seen as beyond control;
hence the investment in attempts to contain perceived opportunities and limit
executive incentives. Arguably, this is due to the ease of approaching the problem;
after all, tackling the human side of control, especially self-regulation, is an
enormous challenge. Any attempts to put our arms around it are fraught with high
risk of failure. Emphasizing what can be worked on, we may have overdone the
exercise of control on the environment. Testing for the significance and materiality
of control compromises invariably absorbs those who should guard the guardian into
controls that detect or prevent employee fraud, not management fraud. Higher-level
controls relevant to executive fraud risk are recently in the spotlight. Indeed, the
DFC favors this promising development, although not all higher level controls pass
the test of effectiveness from the DFC.
Environment
The DFC model suggests that we need to shift focus from occurrences of
compromise to the processes that lead to a breakdown in executives resolve. While
these processes are primarily internal to the executive, the understanding of the
environment in which breakdowns occur should prove helpful. For this to occur, we

D F C | 33
need to comprehend the nature of ego depletion and psychological inertia, and the
process leading to comparison of short- and long-term gains. It is necessary to know
what kind of rewards the executive would compare in the case of moral breakdown
leading to financial fraud.
Another key dimension that warrants new lenses is the traditional view of controls
that emphasize past or anticipated occurrences. We argue that such occurrencebased controls are not the same as obstacles, which appear to be more opportunityneutral. After all, since temptations come in many different shades, it is difficult to
rely upon a standard set of controls. It is therefore necessary to take a close look at
the nature of obstacles and their role in moral temptations that concern financial
fraud. Additionally, further insights can be gained by differentiating between
obstacles that counter the first offense versus those that challenge repeated
offenses.
Disposition
Clearly, the notions of disposition, as with narcissism, are soft. However, these are
the virtue traits that are stable and, once understood, can be relied upon to predict
the agents behavior. Both disposition and narcissism can be assessed through
administration of appropriate instruments. The difficulty is in getting genuine
responses, countering impression management by the executive. For this reason,
researchers often explore indirect ways to measure surrogates. Chatterjee and
Hambrick (2007) resorted to five unobtrusive indicators to assess CEO narcissism:
prominence of the CEO in company photographs and press releases, CEOs use of
first-person singular pronouns, and two relative measures of CEO compensation
(CEO cash (non-cash) compensation as a ratio of cash (non-cash) compensation of
the next highest paid executive). To validate their measures of CEO narcissism, they
separately administered Likert-scale type questionnaires to analysts familiar with
the CEOs in the sample. Similarly, Raval (2013c) analyzed CEO philanthropy to
reaffirm the CEOs disposition by examining the nature of charity entertained by the
executive.
Disposition and occurrence are two distinct things; disposition, if identified and
countered properly, could help prevent frauds, while occurrences of fraud can only
be detected and punished. It is important to examine whether an approach to
designing internal controls that places more emphasis on disposition would prove to
be more effective. Considerable agony and waste of wealth can be stopped if an
understanding of executive disposition, no matter how hard it may be to identify
and address, will help prevent leadership failures. Familiarity with the person in
various settings, both formal and informal, business and non-business, should help
gauge the persons disposition. The CEOs known to follow rigorous regimen of yoga
exercises, for example, are less likely to have a P(I) disposition. The longer one
observes the agent, the higher the reliability of the dispositional assessment of the
agent. Consequently, boards should consider it prudent to promote from within

D F C | 34
capable persons who they know well over time. 33 There are, however, limits to this
approach, for several other factors are involved in the recruitment of executives,
and internal succession may not be the best option in a given situation. In such
cases, a conscious search for all externally available evidence should be undertaken
and considered to assess as best as possible the candidates disposition.
Given that both the CEO and CFO may be involved in financial fraud, it is necessary
to also conduct an assessment of the collective (CEO and CFO, for example) to
gauge whether both dispositions border on P(I) tendencies, for this could create a
heightened possibility of fraud. Conversely, if dispositions of both tend toward P(E),
the DFC model would predict that the act would likely not occur. In cases where
CEO-CFO dispositions are mixed (one P(I) and the other, P(E)), it would be of interest
to examine whether the dominant player is of P(I) disposition, the collaborator is of
P(E) disposition, and whether the former could pressure the latter into the role of
accomplice. In a notable study concerning the joint involvement of CEOs and CFOs
in material accounting manipulations, Feng et al (2011) compiled a sample of 499
firms after reviewing 2,261 AAERs issued by the SEC between 1982 and 2005. They
then used this base sample along with a control sample to perform legal cost
analysis for CFOs. The findings suggest that CFOs, when involved, do not
collaborate for pecuniary incentives, but rather succumb to the pressure from the
CEO, thus deciding to break their resolve. The CFOs who resisted the pressure left
the firm within a period of three years prior to the act of accounting manipulation.
The DFC model would predict that these CFOs were of P(E) disposition. 34
Finally, as noted earlier, powerful executives exert their influence in constructing
the internal environment. Because it is a reflection of their disposition, it is largely
entrenched in the organization; others responsible for governance, despite all the
regulatory requirements, may not be able to change essential nature of the tone.
Executive disposition and internal environment may be inseparable in motive, at
least to the extent that the environment is controlled by the executive. Thus, poor
tone at the top forecasts P(I) disposition of the leadership.
Table 2. Selected research agenda emerging from the DFC model.
JUDGMENT SHIFT:

Identify factors leading to judgment shift in a financial fraud.

EGO DEPLETION:

Examine if ego depletion was present in past cases of executive financial fraud.

Examine the effect of company performance volatility on ego depletion of CEOs.

33 In a recent survey conducted by Stanford University and the executive search firm Heidrick &
Struggles, 140 CEOs and directors participated. When asked whether their company was grooming a
specific executive to succeed the current CEO, 54 percent responded yes, while 46 percent said no.
Source: Succession Dos and Donts, Willa Plank, The Wall Street Journal, April 28, 2014, R3.

34 The literature on cooperative and competitive processes involved in joint act is vast. See, for
example, Deutsch (1973), Rubin (1995), and Kahneman (2011).

D F C | 35
REWARDS:

Investigate whether executives of companies that eliminate the practice of giving guidance
are less likely to commit financial fraud. The assumption is that absence of guidance
removes the stimuli forcing the breakdown of resolve.

Using the concept of Just Noticeable Differences35, investigate if judgment shift would not
occur when long term rewards are an order of magnitude larger than the short term rewards.
Keep the perceived attainability of the long term rewards high.
OBSTACLES:

Conduct an analysis of the nature, timing, and structure of obstacles potentially effective in
detecting or preventing fraud.

Study the differences, if any, between obstacles relevant to (1) an initial act of fraud and (2)
persistent (addiction-like) acts of fraud.

Investigate the effect of timing when an obstacle is triggered close to the fraudulent act.
Test for incentives to informants based on timing of the fraud alert.
CONTROLS:

From the perspective of the design of control frameworks, identify the nature and
characteristics of temptations, as distinguished from opportunities.

Examine the role of occurrence-based and opportunity-neutral controls.

SELF-EFFICACY:

Assess frequently the level and effectiveness of independence of the CFO from the CEO.
Adopt practices and procedures at the board level to achieve this objective.

Encourage the audit committee to maintain direct contact with the CFO and strengthen this
relationship.
DISPOSITION:

Recruit C-level team by placing extensive efforts to assess the candidates disposition.
o Assuming disposition of executives with long tenure with the company is better
known, where possible, promote from within.

The sheer number of executives with P(I) disposition concurrently serving in the C-level suite
can pose a significant fraud risk. Assess the disposition of the collective in the C-suite. If two
or more executives reflect P(I) disposition, guard against possibilities of compromises
through governance processes.

CEO and CFO disposition: A. Where the CEO is of P(I) disposition and the CFO is of P(E)
disposition, examine the effects of strengthening the independence of the CFO. B. Where the
CEO is of P(E) disposition and the CFO of P(I) disposition, test the likelihood that self-efficacy
of a financial fraud is enhanced. C. Where both the CEO and CFO are of P(I) disposition, test
if frequent reviews of controls that rely on their independence from each other could help
prevent fraud.

Investigate whether executives with P(E) disposition can handle pressures better that those
with P(I) disposition.

Identify the nature of relationship, if any, between P(I) disposition and narcissism.

Are independent directors (specifically audit committee members) and chief audit
executives are best suited to gauge the disposition of the executive because they have
adequate access to the executive in various settings?

Should the external auditors ask for an assessment of disposition of top management team
from non-officer directors?

Barnard (2009) recommends the board should consider adding an agenda item: a
systematic senior executive pathology audit with a view to tease out behavioral
problems, and squarely address the issue of CEO pathology. Johnson et al (2013)
investigated auditor perceptions of client narcissism; they found that auditors are aware of
the link between client narcissism and increased fraud attitude risk.

35 The minimum difference in stimulation that a person can detect 50 percent of

the time.

D F C | 36

Limitations and Concluding Remarks

An important contribution of this research is in offering an alternative model of
financial fraud that incorporates the human side. The model is constructed ground
up, without resorting to any currently existing fraud paradigm. Model building is an
effortful exercise, and its benefits hinge deeply upon its initial acceptance by the
research community for testing and validation. Although consistent with and
supported by published literature, the DFC model remains to be validated to
establish its relevance; however, this will take time and initial acceptance of the
model, albeit on some faith, is a necessary first step.
To simply suggest that the breakdown of a moral resolve in the face of contrary
inclinations triggers fraud is not enough. If this research is found promising, the next
step is to investigate the specific nature of disposition, and the granular aspects of
the process that drives the moral meltdown. Whereas a higher level understanding
of how temptation actualizes as an act is helpful, specific answers are necessary to
bring forward the model to a working stage. For example, in the process of
comparison of short term and long term rewards, what rewards do executives take
into consideration, how are these measured, what time frame might be involved,
and what tips the scale in favor of short term gains these are all significant
questions that should lead to further development of the model.
Much of what the DFC model has to offer has not been previously tested, or tested
in a holistic sense. Sure enough, relying on the wealth of investigation by
researchers of the ranks of Beaumeister, Azjen, and Holton and their colleagues
provides a sound footing. And yet, the specific context of financial fraud warrants
that we test the model thoroughly. For example, studies of temptation often involve
younger people without any business understanding. Their comparison of
immediate and long term rewards involves relatively trivial and short-lived
incentives (candy vs. carrots). Consequently, importing some of the conclusion from
such research requires additional testing for the model to gain practical
significance. And this is unlikely to be easy, for the data collected thus far in the
domain of financial fraud research appear to lack inputs relevant to the DFC model.
But this challenge in itself, if properly addressed, could lead to significant further
insights into the chronic problem of financial fraud.
Undoubtedly, what has been laid out here will generate more questions, questions
pertaining to further articulation, measurement of specific variables, such as ego
depletion, and design of studies to test various propositions. The rewards of these
efforts can be significant; if the model delivers it promise, it could impact radically
the practice of corporate governance, the identification of fraud risk factors, and
efficient development of potentially effective antidotes.

D F C | 37
Albert Einstein once remarked, If at first, the idea is not absurd, there is no hope
for it. The DFC model may appear far-fetched; however, it is a first comprehensive
exercise in building a new vision from ground up. There is a sign of upside potential
in the model. The model, if proven valid, can help prevent corporate meltdowns,
improve effectiveness of regulation, enhance audit efficiency and productivity, and
sharpen control frameworks to focus on the key drivers of executive fraud.
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