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INDICATORS OF MANAGEMENT FRAUD IN COMMUNITY BANKS

by

Michael J. McAteer

September 2008

A Dissertation Presented in Partial Fulfillment

of the Requirements for the Degree

DOCTOR OF BUSINESS ADMINISTRATION

UNIVERSITY OF PHOENIX

September 2008
ii

© 2008 by Michael J. McAteer


ALL RIGHTS RESERVED
ABSTRACT

Focus of the quantitative correlational study was the relationship between occurrence of

management fraud in community banks in United States and financial ratios the Federal

Deposit Insurance Corporation uses to monitor safety and soundness of banks.

Theoretical framework reflected the concept of Analytic Model of Management Fraud in

Community Banks, and that financial statements using financial ratios provide a lens to

view the actions of management. Using logistical regression, three groups of financial

ratios (i.e., performance, growth, and capital) were tested in the model for a period of

three years prior to the occurrence of management fraud. The performance ratio logistical

regression model provided strong and consistent predictive results over multiple

timeframes. The results of study support incorporating foundational concepts of

management fraud into the Analytic Model of Management Fraud in Community Banks.

Revised Analytic Model of Management Fraud in Community Banks was developed to

provide leaders and stakeholders a tool for the detection and prevention of management

fraud.
v

DEDICATION

This is dedicated to my loving wife Andrea. Her patience and understanding

provided the strength to complete this project.


vi

ACKNOWLEDGMENTS

I would like to acknowledge and thank my committee members, Dr. Kewal

Verma, Dr. Toni Greif, and Dr. Steve Seteroff. At the first year residency, Dr. Seteroff

provided encouragement and insight that this was within my grasp. Dr. Toni Greif

inspired me to bring together interdisciplinary concepts to a problem. She helped create

the first big idea. Dr. Kewal Verma has been an anchor to keep me focused and on task

for which I specially wish to thank him.

I would also like to acknowledge the Mindbenders, my first learning team, and all

the other members of the cohort. Your friendship made the journey worthwhile and most

pleasant.
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TABLE OF CONTENTS

LIST OF TABLES....................................................................................................xi

LIST OF FIGURES ................................................................................................xiii

CHAPTER 1: INTRODUCTION ..............................................................................1

Background of the Problem ....................................................................................... 3

Statement of the Problem...........................................................................................7

Purpose of the Study ..................................................................................................8

Significance of the Study ........................................................................................... 9

Nature of the Study ..................................................................................................10

Research Questions..................................................................................................13

Hypotheses............................................................................................................... 16

Conceptual Framework............................................................................................ 17

Definition of Terms..................................................................................................21

Terms Related to the Study...............................................................................21

Logistic Regression Analysis Terminology......................................................27

Assumptions.............................................................................................................28

Limitations ...............................................................................................................29

Delimitations............................................................................................................ 30

Summary .................................................................................................................. 30

CHAPTER 2: LITERATURE REVIEW .................................................................32

Documentation.........................................................................................................32

Historical Overview ................................................................................................. 34

Management Fraud ..................................................................................................37


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The Causes of Management Fraud ...................................................................40

Managerial Discretion ......................................................................................41

Ethical Behavior ...............................................................................................42

Institutional Anomie Theory.............................................................................43

Agency Theory ................................................................................................. 44

Management Fraud Detection..................................................................................45

Management Fraud Prevention ................................................................................46

Organizational Decline ............................................................................................ 48

Corporate Failures ............................................................................................48

Banking Failures............................................................................................... 50

The Banking Industry ..............................................................................................52

Overview...........................................................................................................52

Community Banks ............................................................................................56

Indicators of Financial Condition and Management Fraud ..................................... 58

Conclusion ............................................................................................................... 63

Summary .................................................................................................................. 64

CHAPTER 3: RESEARCH METHODS .................................................................66

Research Design....................................................................................................... 66

Research Design Appropriateness ........................................................................... 73

Logistic Regression Model ......................................................................................74

Research Questions..................................................................................................75

Hypotheses............................................................................................................... 77

Population ................................................................................................................78
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Sampling Frame .......................................................................................................79

Geographic Location................................................................................................81

Informed Consent and Confidentiality.....................................................................81

Data Collection ........................................................................................................82

Call Reports ............................................................................................................. 84

Research Instruments ............................................................................................... 85

The Logistic Regression Model Formula .........................................................85

Instrument Validity........................................................................................... 86

Internal and External Validity..................................................................................87

Objectivity................................................................................................................87

Reliability .........................................................................................................87

Internal Validity................................................................................................88

External Validity...............................................................................................88

Data Analysis ........................................................................................................... 89

Performance Ratios...........................................................................................89

Growth Ratios...................................................................................................90

Capital Ratios....................................................................................................91

Computational Issues for Logistic Regression .................................................92

Summary .................................................................................................................. 94

CHAPTER 4: RESULTS.........................................................................................96

Review of Data Collection Procedures ....................................................................97

Descriptive Statistics................................................................................................99

Performance Ratio Model H1.........................................................................101


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Growth Ratio Model H2 .................................................................................102

Capital Ratio Model H3..................................................................................103

Findings..................................................................................................................103

Analysis of Logistical Coefficients........................................................................109

Performance Ratios................................................................................................110

Performance Ratio Model H11(t-1) ...................................................................111

Performance Ratio Model H11(t-2) ...................................................................112

Performance Ratio Model H11(t-3) ...................................................................113

Revised Performance Ratio Model H12 ..........................................................114

Growth Ratios ........................................................................................................118

Growth Ratio Model H21(t-1) ...........................................................................119

Growth Ratio Model H21(t-2) ...........................................................................121

Growth Ratio Model H21(t-3) ...........................................................................121

Capital Ratio Model............................................................................................... 123

Capital Ratio Model H31(t-1) ............................................................................124

Capital Ratio Model H31(t-2) ............................................................................126

Capital Ratio Model H31(t-3) ............................................................................127

Validity and Outliers..............................................................................................129

Summary ................................................................................................................ 130

CHAPTER 5: CONCLUSION AND RECOMMENDATIONS ........................... 132

Conclusions............................................................................................................ 132

Performance Ratio Model H1.........................................................................133

Growth Ratio Model H2 .................................................................................134


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Capital Ratio Model H3..................................................................................135

Logistic Regression Coefficients....................................................................136

Limitations .............................................................................................................136

Implications............................................................................................................136

The Analytic Model of Management Fraud in Community Banks .......................140

Recommendations..................................................................................................141

Recommendations for Leaders .......................................................................141

Recommendations for Research .....................................................................142

Summary and Conclusion ...................................................................................... 142

REFERENCES ......................................................................................................144

APPENDIX A: INFORMED CONSENT .............................................................157

APPENDIX B: SAMPLE OF FDIC ENFORCEMENT ORDER.........................159

APPENDIX C: SAMPLE OF A COMMUNITY BANK FDIC STATISTICAL

DOWNLOAD ........................................................................................................ 162

APPENDIX D: DESCRIPTIVE STATISTICS FOR THE PERFORMANCE

RATIO MODELS.................................................................................................. 165

APPENDIX E: T-TESTS FOR THE PERFORMANCE RATIO MODEL ..........175

APPENDIX F: HISTOGRAMS ............................................................................185

APPENDIX G: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODEL .................................................................................................................228

APPENDIX H: TOLERANCE AND VARIANCE INFLATION FACTORS ..... 230

APPENDIX I: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODELS ............................................................................................................... 232


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APPENDIX J: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODEL .................................................................................................................235

APPENDIX K: CORRELATION MATRIX......................................................... 238

APPENDIX L: VALIDATION ANALYSIS......................................................... 251

APPENDIX M: VALIDATION LIFT...................................................................253

APPENDIX N: CASEWISE LIST ........................................................................ 257

APPENDIX O: ANALYSIS OF OUTLIERS ....................................................... 259


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LIST OF TABLES

Table 1 Performance Ratios ...................................................................................15

Table 2 Summary of Literature Review ...................................................................33

Table 3 Breakout of Primary Regulator of FDIC Insured Banks (2006) ................55

Table 4 Banks Under $1 Billion in Assets-1996 to 2006 .........................................56

Table 5 Performance Ratio Variables .....................................................................70

Table 6 Growth Ratio Variables ..............................................................................71

Table 7 Capital Ratio Variables ..............................................................................72

Table 8 Control Variables .......................................................................................73

Table 9 Number of Significant Variables by Hypothesis .......................................100

Table 10 Null Hypotheses Analysis........................................................................105

Table 11 Overall Model Fit of Alternative Hypotheses .........................................105

Table 12 Alternative Hypotheses Model Summaries .............................................107

Table 13 Percentage Accuracy Classification.......................................................108

Table 14 New Performance Ratio Model H12 Variables.......................................115

Table 15 Tolerance and VIF Levels in H12 ...........................................................116

Table 16 Comparative Model Fit of H11 and H12 .................................................117

Table 17 Odds Ratios for H12 Significant Variables .............................................118

Table 18 Description of Variables in Growth Ratio Model H21(t-1) .......................120

Table 19 Tolerance and VIF Levels in H21(t-1) .......................................................121

Table 20 Description of Variables in Growth Ratio Model H21(t-3) .......................123

Table 21 Tolerance and VIF Levels in H21(t-3) .......................................................123

Table 22 Description of Variables in Capital Ratio Model H31(t-1) .......................125


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Table 23 Tolerance and VIF Levels in H31(t-1........................................................125

Table 24 Description of Variables in Growth Ratio Model H31(t-2) .......................126

Table 25 Tolerance and VIF Levels in H31(t-2) .......................................................127

Table 26 Description of Variables in Capital Ratio Model H31(t-3) .......................128

Table 27 Tolerance and VIF Levels in H31(t-3) .......................................................128

Table 28 Number of Outliers by Hypothesis..........................................................130


xiii

LIST OF FIGURES

Figure 1. Comparison of failure and prohibition enforcement actions from 1996

to 2006. ...................................................................................................................... 6

Figure 2. The analytic model of management fraud in community banks..............69

Figure 3. Revised Analytic Model of Management Fraud in Community Banks. 141


1

CHAPTER 1: INTRODUCTION

Management fraud refers to deliberate actions to deceive shareholders and

stakeholders for the managers’ own purposes (Zahra, Priem, & Rasheed, 2005). Despite

efforts to improve corporate governance and align management and shareholder interests,

the incidence of management fraud has increased since the 1980s. The promulgation of

codes of conduct has not mitigated fraud increases. The study of management fraud

applies to many disciplines, yet the literature includes only a few empirical studies on its

causes, detection, and prevention (Smith, Simpson, & Huang, 2006).

In the regular course of business, leaders face ethical dilemmas that require the

use of moral values, judgments, codes of conduct, and fundamental concepts of right and

wrong (Kavali, Tzokas, & Saren, 1999). The ethical and legal consequences of business

leaders’ decisions can be far reaching. The ethical dilemmas of leaders have common

characteristics, extended consequences, multiple alternatives, mixed outcomes, uncertain

consequences, and personal implications (Hosmer, 1996). When managers engage in

unethical, fraudulent, or criminal behavior, the effects are far reaching and damaging to

the business organization and the community. When managers of banks are involved in

unethical, fraudulent, or criminal behavior, the consequences can be significant because

of the economic role banks perform in communities (Benston, 2004).

In the United States, banks are financial intermediaries providing an economic

catalyst by facilitating payments and channeling credit to individuals and businesses

(Samolyk, 2004). The banking system and its regulation are built upon a bond of trust

between the depositors and the bank. Federal regulators protect such trust by monitoring

the safety and soundness of the banking system (Federal Deposit Insurance Corporation
2

[FDIC], 2007c). Management fraud in a bank affects the viability of the bank as a

financial intermediary and an ongoing business. Management fraud in a bank breaks the

bonds of trust with the community of bank stakeholders.

Community banks are small banks with less than $1 billion in assets that provide

a significant and disproportionate share of banking services to small businesses and rural

communities (Critchfield et al., 2004). Management fraud in a community bank is

particularly damaging to the local community and the market segments it serves.

Identification of the occurrence of management fraud can prevent or mitigate damage to

the trust between stakeholders in local economies and can enhance economic

development.

Management fraud has increased since the 1980s and has become a worldwide

problem (Zahra et al., 2005). Management fraud is a widely accepted topic for research in

many fields and disciplines. Despite evidence of the debilitating effects of management

fraud and the interest in the phenomenon, there have been few empirical studies on the

cause, detection, and prevention of management fraud. The purpose of the current study

was to examine with a quantitative correlational design the financial ratios federal

regulators use in monitoring banks for safety and soundness as a method of detecting

management fraud in community banks in the United States.

Chapter 1 begins with an introduction to the specific problem the research has

addressed, statements of purpose and significance of the study, and a overview of the

conceptual framework that represents the theoretical foundation of the research endeavor.

Sections subsequent to the introductory paragraphs include the research questions and

details of the nature of the study with an outline of the chosen methodology. The current
3

study findings add to the literature and body of knowledge with implications for

leadership. The focus of the quantitative correlational study was the examination of the

relationship between the occurrence of management fraud in community banks in the

United States and financial ratios used by the FDIC to monitor the banks’ safety and

soundness.

Background of the Problem

Management fraud occurs in all types of organizations and presents a persistent

and increasing problem (Zahra et al., 2005). Most of the literature concerning

management fraud covers multiple areas that include (a) issues of ethical behavior

(Anand, Ashforth, & Joshi, 2004; Cullen, Parboteeah, & Hoegl, 2004; Ludwig &

Longenecker, 1993; Traynor, 2004), (b) the effectiveness of corporate governance

(Beasley, Carcello, Hermanson, & Lapides, 2000; Crutchley, Jensen, & Marshall, 2007;

Griffith, Fogelberg, & Weeks, 2002), and (c) the use of auditing controls in stopping

management fraud (Kaminski, Wetzel, & Guan, 2004). A broad definition of

management fraud is intentional management activities that injure stakeholders through

the issuing of misleading financial statements (Elliot & Willingham, 1980). Management

consists of the individuals who control or are beyond the control of internal safeguards

within organizations.

Management fraud can appear to be unstoppable (Tipgos, 2002). Managers of an

organization ultimately control the mechanisms used to ensure compliance and safeguard

the organization. Managers can override internal controls that block their personal

objectives. In the case of the Enron fraud, the company board of directors voted twice to

override its own code of ethics in order to setup the financial partnerships that were the
4

fraudulent vehicle in their collapse (Tipgos, 2002). The changing business environment

presents new challenges associated with management behavior. New methods and

approaches to the detection, prevention, and resolution of management fraud depend

greatly on continuing research in the field (Elliot & Willingham, 1980).

The banking industry has traditionally occupied a unique position within the

economy of the United States because of the special economic role banks perform in

facilitating payments and channeling credit to individuals and businesses (Samolyk,

2004). Bank regulators such as the FDIC, the Office of the Comptroller of the Currency

(OCC), the Board of Governors of the Federal Reserve (FRS), and the Office of Thrift

Supervision (OTS) monitor the banking industry to ensure its continuing financial

viability (FDIC, 2006). The special economic role that banks perform brings together the

interests of stakeholders that include the public, depositors, and government regulators

(Simpson & Gleason, 1999). The occurrence of management fraud at community banks

affects all stakeholders’ interests.

An analysis of failed national banks under the regulatory oversight of the OCC

(1988) indicated that 90% of bank failures resulted from poor management and that

almost one third of the 90% included fraud by the bank’s management. Researchers for

the U.S. General Accounting Office [USGAO] (1994) studied 286 banks that failed in

1990 and 1991 and reported insider abuse, insider fraud, or loan losses to insiders in 61%

of the failed banks. A study by the FDIC (1997) of banks during the years 1980 to 1994

indicated a large percentage of bank failures where incidents of management fraud and

that management fraud was a significant contributing factor to the banks’ failure.
5

Community banks have less than $1 billion in assets and represent 94% of all

institutions within the banking industry (Critchfield et al., 2004). In the years 1998 to

2002, community banks represented a disproportionate share of losses to the FDIC.

During the same years, community banks represented 63% of failed bank deposits

insured by the FDIC and 72% of the failure costs.

Federal regulators have produced onsite and offsite monitoring systems to identify

and monitor banks whose safety and soundness might be in question (Curry, O’Keefe,

Coburn, & Montgomery, 1999). Federal regulators review community banks on a

quarterly basis, using offsite reviews of mandated financial statements. Part of the review

includes an analysis of financial ratios from the banks’ financial statement. The analysis

includes over 30 financial ratios such as performance, growth, and capital ratios to

determine a bank’s relative susceptibility to financial failure or distress.

The FDIC Improvement Act of 1991 (FDICIA) required the FDIC to act quickly and

infuse new or additional capital into financially distressed banks. The FDIC often infuses

new or additional capital into financially distressed banks by merging the distressed bank

with a healthier institution (Elsas, 2007). Since the time of the OCC, USGAO, and FDIC

studies, the number of bank failures has decreased, but the incidence of management

fraud, as defined in the current study, has increased since 2002 (FDIC, 2007a). Earlier

researchers have suggested a relationship between management fraud and failure (FDIC,

1997), but the results of studies attempting to predict the onset and mitigate the

consequences of management fraud have produced conflicting results (Beasley et al.,

2000; Griffith et al., 2002; Kaminski et al., 2004).


6

Figure 1 shows the relationship between management fraud as defined in the

current study and bank failure. The historical relationship between management fraud and

bank failure suggested in previous studies (OCC, 1988) appears to be taking opposite

directions. From 1996 to 2001, the number of enforcement orders of terminations or

prohibition fell from over 70 in 1996 to 13 in 2001. During the same period, there were

six bank failures in 1996 and four in 2001, averaging 4.8 failures per year. The number of

termination or prohibition enforcement orders has increased since 2001 while the number

of bank failures has decreased (FDIC, 2007b). Since 2001, the number of enforcement

orders has risen from 13 in 2001 to 90 in 2006. During the same period, the number of

bank failures has decreased from 11 in 2002 to none in 2005 and 2006.

100
90
80
Number of Institutions

70
60
Failures
50
Prohibition/terminations
40
30
20
10
0
06
03

04

05
96

97

98

99

00

01

02

20
20

20

20
19

19

19

19

20

20

20

Year

Figure 1. Comparison of failure and prohibition enforcement actions from 1996 to 2006.

Adapted from FDIC Enforcement Decisions and Orders by FDIC (2007b). Retrieved March 17,

2007, from http://www.fdic.gov/bank/individual/enforcement/index.html


7

Statement of the Problem

Billions of dollars are lost each year from the failure of all types of organizations,

causing the economic dislocations of thousands of workers (Graham, Litan, &

Sukhtankar, 2002). Failures in the banking industry have similar consequences (FDIC,

1997). In many cases, management has concealed the true condition of the organization

or caused the failure by inappropriate action (The Committee of Sponsoring

Organizations [COSO], 1987).

Management misbehavior or fraud contributes to or exacerbates the level of loss

in failure. Since 2002, the number of bank failures has decreased, but the incidence of

management fraud as defined in the current study has increased (FDIC, 2007b). A FDIC

(1997) study of banks during the years 1980 to 1994 indicated that a large percentage of

bank failures had incidents of management fraud. Management fraud was a significant

contributing factor to the banks’ failure.

The banking industry has traditionally occupied a unique position within the

economy because of its special role in facilitating payments and channeling credit to

individuals and businesses (Samolyk, 2004). Management fraud in a banking institution

threatens the viability of the institution and causes disruption to the bank’s role as

financial intermediary. Management fraud at a community bank creates distrust with the

community of bank stakeholders and causes significant damage to the local community

and local economic activities. Through the application of a quantitative correlational

design, the current study produced findings regarding the predictive value of financial

ratios the FDIC uses in monitoring banks as a method of detecting management fraud.
8

Purpose of the Study

The purpose of the quantitative correlational study was to examine the

relationship between the occurrence of management fraud in community banks in the

United States and financial ratios the FDIC uses to monitor the banks’ safety and

soundness. Earlier studies by the OCC (1988), USGAO (1994), and the FDIC (1997)

indicated there might be a link between the occurrence of management fraud and

financial failure. The dependent variable in the study was the occurrence of management

fraud. Performance, growth, and capital ratios were the three groups of financial ratios

that represented the independent variables. The FDIC has used performance, growth, and

capital ratios as determinants of a community bank’s financial condition during the years

1996 to 2003. The examination of these groups of financial ratios facilitated drawing

inferences regarding the ratios’ ability to predict the dependent variable, occurrence of

management fraud.

The control variables for the study were asset size, location, and the time of the

occurrence of management fraud. The control variables controlled extraneous economic

conditions. Previous researchers (Altman, 1983; Basel Committee on Banking

Supervision [BCBS], 2004; Cebula, 1999) identified regional and macroeconomic

conditions as influencing the occurrence of financial failure. By matching the control and

experimental groups within the study by size and location during the same period, the

same economic factors existed in each group.

Studies of bank failures have indicated a significant portion of failed banks have

high incidents of management fraud (FDIC, 1997; OCC, 1988; USGAO, 1994). Small

banks with assets under $1 billion, also known as community banks, provide services to
9

small businesses and the agricultural industry. Community banks are increasingly

important to both market segments (Critchfield et al., 2004; Samolyk, 2004). The

interruption of banking services to the market segments served by community banks

would cause disastrous regional and macroeconomic consequences.

Significance of the Study

Financial failures cause the loss of billions of dollars each year and the economic

dislocations of thousands of workers (Graham et al., 2002). Central banks around the

world recognize that bank failures exacerbate cyclical economic downturns and can

aggravate a financial crisis (BCBS, 2004). Banks are primary channels of credit, and their

failure can have widespread economic impacts. While not all bank failures are caused by

fraud, the root cause of many collapses has been the fraudulent conduct of senior

management at the banks (FDIC, 1997; OCC, 1988; USGAO, 1994).

Managers and business leaders are as ethical and hardworking as any other

segment of the workforce but are also a product of the workplace environment

(Sutherland, 1973; Trevino & Brown, 2004). Managers and leaders recognize that the

underpinning of leadership is trust (Reina & Reina, 2006). The misbehavior of managers

and leaders within an organization undermines the trust that supports leadership and

impairs the stakeholder community (Elliot & Willingham, 1980).

Community banks are major providers of financial services to small businesses

and the agricultural industry. Such services are based on relationships with the customers,

creating trust amongst customer stakeholders (Critchfield et al., 2004). The importance of

community bank lending to the economic sectors small businesses and the agricultural

industry represent is increasing. Community banks are increasingly important as leaders


10

of the local economy, and their performance is a local economic catalyst (Critchfield et

al., 2004).

Managerial fraud is a behavior that directly contradicts the principles of

transformational leadership. While research about leaders and their qualities is abundant,

the topic of why a leader or manager behaves in an unethical manner is underresearched

(Feeley, 2006). The definition of management fraud used in the current study was a FDIC

enforcement decision or order, specifically a termination or prohibition order against an

individual employed by the bank, declaring the individual to have engaged in personal

dishonesty against the bank (FDIC, 2005b). Management fraud in a bank affects the

viability of the bank as a financial intermediary and an ongoing business (BCBS, 2004).

Management fraud in a bank is an attack on the trust developed with bank stakeholders

(Elliot & Willingham, 1980).

Leadership, particularly transformational leadership, is a key component in

building trust with a community of stakeholders (Burns, 1978). The pursuit of higher

goals or values that produce change in a group characterizes transformational leadership

(Burns, 1978). Transformational leaders are concerned with end values, “Leaders ‘raise’

their followers up through levels of morality” (Burns, 1978, p. 426). The focus of the

current study was the dysfunction that management fraud brings to community banks and

the possible methods of early detection of management fraud.

Nature of the Study

Approaches to research can be qualitative, quantitative, or mixed with qualitative

and quantitative components. The basis for choosing a research approach should be

matching the research approach to the research problem (Karami, Rowley, & Analoui,
11

2006). The quantitative approach to the current study was appropriate because the

research problem involved identifying predictive methods to detect management fraud.

The qualitative approach is useful to study a central question or phenomenon in

an effort to explain the phenomenon. The quantitative research approach is appropriate

when the intent is “a description of trends or an explanation of the relationship among

variables” (Creswell, 2003, p. 50). The purpose of the quantitative correlational study

was to examine the relationship between the occurrence of management fraud in

community banks in the United States and the financial ratios the FDIC uses to monitor

the safety and soundness of banks.

Quantitative research problems involve showing the influence that one or several

sets of variables have on other variables. The following four criteria determine the

appropriateness of the quantitative research approach: (a) measurement of the variables is

possible, (b) assessing the impact of the variables is possible, (c) the results can be used

to test theories or provide broad explanations, and (d) the results can apply to a large set

of people (Creswell, 2003). In the current study, the independent variables were

performance, growth, and capital ratios as determinants of a community bank’s financial

condition. The dependent variable was the occurrence of management fraud in United

States community banks. The goal of the research was to determine the ability of the

ratios to predict fraud.

A correlational research design facilitates the measurement of the degree of

association between the variables (Creswell, 2003). Correlation research designs are

appropriate where the study attempts “to explain an association between two or more

variables or to predict an outcome” (Creswell, 2003, p. 363). The association examined in


12

the current study was the relationship between the occurrence of management fraud and

the financial condition of a community bank in the United States as measured by the

financial ratios used by the FDIC.

The application of a matched pairs sample design to the occurrence of

management fraud at community banks led to the creation of an experimental group and a

control group. In the matched pairs design, each member of the control group is matched

to a member of the experimental group by one or more characteristics (Creswell, 2003).

Earlier researchers of management fraud have used a matched pairs design in testing

fraud and the effects of boards of director composition, accounting procedures, and senior

management demographics (Beasley et al., 2000; Crutchley et al., 2007; Saksena, 2001;

Williams, Barrett, & Brabston, 2000).

The matched pairs design allows for the accounting of extraneous factors that

might influence the dependent variable (Eachus, 2006). In the current study, the matching

process allowed the control of local and macroeconomic conditions that can affect a

bank’s overall financial condition (Altman, 1983; BCBS, 2004; Cebula, 1999). The

matching factors were asset size, location, and year of occurrence of management fraud.

The matched pairs design ensured that the matched community banks had similar

operating conditions.

The population of the study was community banks in the United States.

Community banks are institutions that take deposits and focus on lending to a specific

local economy (Anonymous, 2003; Hein, Koch, & MacDonald, 2005). Community banks

tend to be small in terms of asset structure. A total asset base of $1 billion or less is a
13

common level of differentiation. For the current study, the definition of a community

bank was any bank monitored by the FDIC with assets below $1 billion.

Financial statements issued by banking and nonbanking organizations form the

basis for transparency and trust between management of an organization and stakeholders

(Elliot & Willingham, 1980). Financial statements are a documentation of managers’

actions. Management fraud involves overstatement, understatement, or misstatement

within the financial reporting structures (O’Gara, 2004). Ratio analysis of financial

statements is an effective tool in identifying an organization’s probability of future failure

or distress (Altman, 1983).

In the case of community banks in the United States, the primary regulator is the

FDIC (2007a). The FDIC administers depository insurance for member banks to support

confidence and trust in the banking system of the United States. The FDIC monitors its

member banks for safety and soundness and for risks affecting operations and the impact

of an institution’s failure on the banking system (FDIC). The current study was an

examination of the relationship between the occurrence of management fraud in

community banks in the United States and the financial ratios the FDIC uses to monitor

the safety and soundness of the banks.

Research Questions

In quantitative studies, research questions are a means to narrow the purpose of

the study (Creswell, 2003). Research questions synthesize the purpose of the study in

order to focus and craft the relationship to be studied (Cone & Foster, 2003). The

following research question guided the current study: “How does the financial condition
14

of a community bank, as measured by financial ratios used by the FDIC, relate to the

occurrence of management fraud in the bank?”

Banks in the United States operate within a highly regulated environment. The

FDIC, as primary regulator of community banks in the U.S., is charged with monitoring

and maintaining the safety and soundness of community banks (FDIC, 2007a). Previous

researchers have shown increased levels of unethical behavior have occurred in

organizations within various financial conditions such as distress or rapid growth

(Johnson & Rudesill, 2001; Lemke & Schminke, 1991). Financial ratios can be predictive

of future financial condition of an organization and federal regulators use financial ratios

in the monitoring process (Altman, 1983; King, Nuxoll, & Yeager, 2005).

Performance ratios are one type of financial ratios used to measure the relative

performance of an organization within an industry. Performance ratios (e.g., return on

equity, return on assets, net interest margin) are indicators of the relative financial

condition of an organization. Such performance ratios have been used successfully in

models of organizational failure and decline in banks (Dabos & Escudero, 2004). The

FDIC has used the 20 performance ratios listed in Table 1 as indicators of the financial

condition of a community bank. The ratios became independent variables in the current

study.

Rapidly growing organizations produce conditions often associated with

management fraud. A rapidly expanding small business has an increasing risk factor of

fraud, including management fraud (Johnson & Rudesill, 2001). In 1988, the OCC found

overly aggressive growth before a bank’s failure in 42% of the cases examined.
15

Growth ratios are a type of financial ratio the FDIC and other regulators use to

monitor the safety and soundness of banks (King et al., 2005). Four different growth

ratios used by the FDIC as indicators of the financial condition of a community bank are

assets per employee, equity capital to assets, loans and leases plus long-term securities to

assets, and volatile liabilities to assets. Capital ratios are a class of financial ratios used in

predicting credit worthiness (Altman, 1983).

Table 1

Performance Ratios

Performance Ratios

Assets per employee Efficiency ratio

Credit loss provision to net charge-offs Cash dividends to net income

Net loans and leases to core deposits Loss allowance to loans

Net loans and leases to deposits Cost of funding assets

Loan loss allowance to noncurrent loans Yield on earning assets

Noncurrent loans to loans Net interest margin

Net operating income to assets Noninterest income to earning assets

Noninterest expense to earning assets Noncurrent assets plus OREO to assets

Net charge-offs to loans Return on assets

Return on equity Retained earnings to average equity

Estrella, Park, and Peristiani (2000) noted that capital ratios were predictors of

bank failure. Regulators use different types of capital ratios to manage the risk-taking

behavior of bank managers. Capital ratios have shown a propensity to predict failures at

differing time intervals. Among capital ratios used by the FDIC as indicators of the
16

financial condition of a community bank, the capital ratios of (a) equity capital to assets,

(b) core capital (leverage) ratio, (c) tier 1 risk-based capital ratio, and (d) total risk-based

capital ratio were used as independent variables in the current study.

Hypotheses

Hypotheses, framed by the research question, produce a specific form of inquiry

(Creswell, 2003). The study hypotheses incorporated financial ratios used by the FDIC as

indicators of the financial condition of a community bank. Three categories of financial

ratios (i.e., performance ratios, growth ratios, and capital ratios) became sets of

independent variables in the study.

Lemke and Schminke (1991) suggested that organizations performing poorly

created conditions conducive to management fraud. The FDIC monitors a bank’s

performance for conditions that affect the solvency of the bank. The inclusion of FDIC

performance ratios in the study led to the formulation of the following hypothesis to be

tested in order to establish the likelihood of management fraud occurring at community

banks:

H10: Community banks with poor performance ratios do not incur an increased

occurrence of management fraud.

H11: Community banks with poor performance ratios have an increased

occurrence of management fraud in subsequent years.

Johnson and Rudesill (2001) and the OCC (1988) suggested that rapidly growing

banks created conditions conducive to the occurrence of management fraud. The FDIC

uses growth ratios to monitor conditions that can affect a community bank’s financial

condition. The inclusion of FDIC growth ratios in the study led to the formulation of the
17

following hypothesis to be tested in order to establish the likelihood of management fraud

occurring at a bank experiencing rapid growth:

H20: Community banks with high growth ratios do not incur an increased

occurrence of management fraud.

H21: Community banks with high growth ratios have an increased occurrence of

management fraud in subsequent years.

Estrella et al. (2000) and the OCC (1988) suggested that poor capitalization of

banks created conditions conducive to financial failure. The FDIC uses capital ratios to

gauge the safety and soundness of banks under its regulatory review. The inclusion of

FDIC capital ratios in the study led to the formulation of the following hypothesis to be

tested in order to establish the likelihood of management fraud occurring at a bank with

low capital ratios:

H30: Community banks with low capital ratios do not incur an increased

occurrence of management fraud.

H31: Community banks with poor capital ratios have an increased occurrence of

management fraud in subsequent years.

Conceptual Framework

Improper, illegal, and fraudulent behaviors on the part of managers and leaders

occur in many disciplines, including criminology, accounting, finance, psychology,

sociology, ethics, economics, and law. Research on fraudulent behaviors in various

disciplines has generated different perspectives and labels (Zahra et al., 2005). Corporate

crime, white-collar crime, unethical behavior, illegal corporate behavior, organizational

crime, corporate wrongdoing, and management fraud are some of the labels used to
18

define illegal behavior in different fields of study. The definition of each label is subject

to a different perspective. Overlapping responsibilities exist regarding oversight of

management by regulators, law enforcement, and outside professionals (Elliot &

Willingham, 1980), making the study of management misbehavior a difficult task.

Management fraud can be the perversion of good and effective management

behavior (Saunders, 1980) and usually requires a deliberate act of financial manipulation

that results in a material misrepresentation of the financial statements of the organization.

The fraudulent act can be the direct manipulation of the accounting records such as

inflating sales or concealing the fraudulent act by false accounting entries as in the theft

of assets (Elliot & Willingham, 1980). The financial reporting system provides

transparency of the actions of management, making the financial statement a tool to

observe or detect the occurrence of management fraud.

Many theorists have attempted to explain why managers behave in unethical or

criminal manners. Sutherland (1973) first coined the phrase white-collar crime in the

1940s. The differentiation the term white-collar crime implies is not in the nature of the

crime but in a demographic of the criminal. Sutherland believed the same basic variables

that prompted ordinary criminal behavior also prompted white-collar crime and defined

exposure to criminal activity as an expective behavior.

An expective behavior defines a situation in which criminal behavior becomes

acceptable without the balancing influences of legal or good behavior. In one of the

earliest studies of management fraud, Cressey (1971) hypothesized that management

fraud contained the three elements of (a) an unsharable financial problem, (b) the

accessibility and control of assets or accounting records, and (c) the ability to rationalize
19

the actions the fraudster takes. Cressey’s contention was that viewing management fraud

purely from the perspective of control and regulation was incorrect and that research of

management fraud needed a behavioral context.

The focus of management behavior studies has been the relationship between

owners and employee managers. Agency theorists posited that, when the goals of

managers diverged from those of stockholders, a change in management behavior

occurred (Jensen, 2004). Meckling and Jensen (1976) first described agency theory as the

relationship between shareholders and the managers hired to run an enterprise.

Managers have their own interests that can conflict with those of shareholders and

stakeholders. The management of conflicting interests generates costs that include the

cost of oversight, compliance, and enforcement and are referred to as agency costs

associated with attempts to control management behavior (Ekanayake, 2004). Incentives,

compensation schemes, and control mechanisms encourage managers to align their

interests with those of shareholders. The misalignment of goals and interests in terms of

misuse, abuse, and diversion of resources and assets because of conflicting interests are

agency costs. Management fraud is an agency cost because of the inherent abuse of

position and authority of managers as evidenced by the fraudulent behavior with agency

costs at its roots that caused the failure of firms such as WorldCom and Enron (Jensen,

2004).

Elliot and Willingham (1980) defined management fraud as “deliberate fraud

committed by management that injures investors and creditors through materially

misleading financial statements” (p. 4). Within Elliot and Willingham’s definition, a

manager is a person who controls or is beyond the control of internal safeguards within
20

an organization. Cressey (1971) and Elliot and Willingham identified accounting records

or financial statements as integral elements of management fraud. Top management of an

organization controls the procedures and processes of the organization, including the

controls that monitor their own behavior.

The American Institute of Certified Public Accountants (AICPA) encourages

accountants and auditors to use red flags as indicators of possible fraud within a

company. According to the AICPA, the use of financial ratios as an analytical tool to

assist auditors in the detection of financial reporting fraud can produce red flag indicators

(Kaminski et al., 2004). In practice, the usefulness of using indicators is debatable

because accountants and auditors interpret the context of red flags differently. Many

accountants do not appreciate the effectiveness of red flags as a predictive tool because of

lack of experience or exposure (Grazioli, Jamal, & Johnson, 2007).

The analysis of financial ratios allows the analyst to compare a relative change in

an organization over time against (a) other organizations, (b) an industry, or (c) preset

benchmarks. Ratio analysis involves using the financial statements of an organization to

identify underlying factors affecting the organization (Palepu, Healy, & Bernard, 2003).

Financial ratios have produced accurate results in predicting financial decline (Altman,

1983). Financial ratios form the basis of the modern predictive models used in credit

decision making. The FDIC uses financial ratios as part of their responsibilities in the

surveillance and monitoring activities of banks to ensure the banks’ safety and soundness

(King et al., 2005).

Because of the regulatory interests that depository insurance creates, banking

institutions are subject to increased regulatory scrutiny. The mission of the FDIC is to
21

protect depositors’ interests at banking institutions by maintaining the safety and

soundness of the banking system. The FDIC attempts to detect unsafe and unsound

practices at banking institutions through physical examinations and the analysis of

financial data. The purpose of enforcement actions the FDIC takes after examinations and

reviews of financial data is to modify or change practices deemed unsafe (Curry et al.,

1999).

Findings from studies of banks and nonbanking organizations have shown that

ownership and agency theory increase the risk-taking behavior of managers (Barnes,

2004; Demsetz, Saidenberg, & Strahan, 1997; Lee, 2002). Excessive risk taking is

associated with failure and unethical behavior (Lemke & Schminke, 1991). The premise

of the current study was that the financial ratios used by the FDIC in monitoring the

safety and soundness of community banks could be predictive indicators of the

occurrence of management fraud.

Definition of Terms

Terms Related to the Study

Assets per employee (ASTEMPM). Assets per employee are the ratio of total

assets to employees, a growth and performance ratio. Total assets are in the millions of

dollars, and the employee count is the number of full-time employees (FDIC, 2005a).

Average assets (ASSET5). Average assets are a control variable used in the

matching process in the current study. Average assets mean the average assets held by the

bank during the reporting period (FDIC, 2005a).


22

Average earning assets (ERNAST5). The phrase is commonly used and means the

average loans, leases, and investments that are earning interest, payments, or dividends

and are held by the bank during the reporting period (FDIC, 2005a).

Cash dividends to net income (IDDIVNIR). Cash dividends to net income are

annual cash dividends declared divided by net income, a performance ratio (FDIC,

2005a).

Community banks. Community banks are institutions that take deposits with a

focus on lending to a specific local economy (Anonymous, 2003; Hein et al., 2005).

Because of the limitation of local economies, community banks tend to be small in terms

of asset structure. A total asset base of $1 billion or less is a common level of

differentiation. While many researchers use a threshold limit as a defining factor, the

scale of operations conducted by the bank also influences the definition of a community

bank (DeYoung, Hunter, & Udell, 2004). In 1999, the Federal Reserve developed a basic

framework for monitoring all complex banking organizations over $1 billion in assets

(DeFerrari & Palmer, 2001). The FDIC monitors most banks that do not fall within the

definition of a complex banking organization (Collier, Forbush, Nuxoll, & O’Keefe,

2003). For the current study, the definition of a community bank was any bank monitored

by the FDIC with assets below $1 billion.

Core capital (leverage) ratio (RBC1AAJ). Core capital (leverage) ratio is core

(Tier 1) capital divided by average assets less ineligible intangible assets, a capital ratio.

Within the definition, core or tier 1 capital is common equity, preferred perpetual non-

cumulative stock, consolidated minority subsidiary interests, and intangible assets.


23

Ineligible intangibles are intangible assets subject to exclusion by regulators (FDIC,

2005a).

Cost of funding earning assets (INTEXPY). Cost of funding earning assets is

annualized total interest expense on deposits and borrowed funds divided by the average

earning assets of the bank, a performance ratio (FDIC, 2005a).

Credit loss provision to net charge-offs (ELNANTR). Credit loss provision to net

charge-offs is the credit loss provisions divided by net charge-offs, a performance ratio

(FDIC, 2005a).

Efficiency ratio (EEFFR). Efficiency ratio is a non-interest expense less

amortized intangible asset expenses divided by net interest income and non-interest

income, a performance ratio (FDIC, 2005a).

Equity capital to assets (EQV). Equity capital to assets is the total equity capital

divided by total assets, a growth and capital ratio (FDIC, 2005a).

Financial ratios. The financial ratios used in the current study were financial

ratios calculated by the FDIC or used by the FDIC. The ratios belong to the three groups

of performance, growth, and capital ratios. Performance ratios are 20 ratios consistently

calculated by the FDIC during the period 1992 through 2006. Growth ratios are four

ratios calculated from FDIC data collected during the period 1992 through 2006. The

growth ratios used in the study are from the FDIC Growth Monitoring System [GMS].

Capital ratios are four ratios consistently calculated by the FDIC during the period 1992

through 2006. Two of the ratios are used in multiple categories. The equity capital to

assets (EQV) ratio is used in both the capitalization and performance groups. The assets

per employee (ASTEMPM) ratio is used in the performance and growth groups.
24

Growth ratio 1 (ROLLPS5TA). Growth ratio 1 is loans and leases plus securities

with a maturity of greater than 5 years divided by total assets, a growth ratio (Sahajwala

& Van den Bergh, 2000).

Growth ratio 2 (ROVLTA). Growth ratio 2 is the amount of volatile liabilities

divided by total assets, a growth ratio (Sahajwala & Van den Bergh, 2000). Volatile

securities is defined by the FDIC as time deposits of $100,000 or more, deposits in

foreign offices, federal funds purchased and repurchased, demand notes to the U.S.

Treasury, and other liabilities for borrowed money (FDIC, 1997).

Loan loss allowance to non-current loans (INRESNCR). Loan loss allowance to

non-current loans is the allowance for loan and leases divided by non-current loans and

leases, a performance ratio (FDIC, 2005a).

Loss allowance to loans (INATRESR). Loss allowance to loans is the allowance

for loan and lease losses divided by total loan and leases less unearned income, a

performance ratio (FDIC, 2005a).

Management fraud. Management fraud has many different definitions in many

different studies (Zahra et al., 2005). The breadth of usage of the phrase management

fraud can make the collection of consistent data on occurrence problematic. Since

management fraud in many instances is a criminal activity, earlier researchers have used

violations of law or regulatory infractions as a proxy for management fraud (Beasley et

al., 2000; Cressey, 1971; Saksena, 2001; Williams et al., 2000). The definition of

management fraud in the current study is a FDIC enforcement decision or order,

specifically a termination or prohibition order against an individual employed by the


25

bank, declaring the individual to have engaged in personal dishonesty against the bank

(FDIC, 2005b).

Net charge-offs to loans (NTLNLSR). Net charge-offs to loans is loans and leases

less recoveries divided by average total loans and leases loans, a performance ratio

(FDIC, 2005a).

Noncurrent assets plus other real estate owned to assets (NPERFV). Noncurrent

assets plus other real estate owned to assets is noncurrent assets divided by total assets, a

performance ratio. Included in the definition of noncurrent assets are nonaccrual assets,

assets 90 days past due, and real estate owned (OREO) (FDIC, 2005a).

Noncurrent loans to loan (NCLNLSR). Noncurrent loans to loan is noncurrent

loans and leases divided by total loans and leases, a performance ratio. Included in the

definition are noncurrent loans and leases are nonaccrual loans and loans and leases 90

days past due (FDIC, 2005a).

Noninterest expense to earning asset (NONIXY). Noninterest expense to earning

asset is expenses other than from interest bearing assets divided by average earning

assets, a performance ratio (FDIC, 2005a).

Noninterest income to earning assets (NONIIY). Noninterest income to earning

assets is income other than from interest bearing assets divided by average earning assets,

a performance ratio (FDIC, 2005a).

Net interest margin (NIMY). Net interest margin is the total interest income less

total interest expense divided by average earning assets, a performance ratio (FDIC,

2005a).
26

Net loans and leases to core deposits (IDLNCORR). Net loans and leases to core

deposits is total loans and leases less unearned income, allowances for loan and lease

losses, and provisions for loan and lease loss divided by core deposits, a performance

ratio. Included in the definition of core deposits are domestic deposits less than $100,000

each (FDIC, 2005a).

Net loans and leases to deposit (INLSDEPR). Net loans and leases to deposit is

total loans and leases less unearned income, allowances for loan and lease losses, and

provisions for loan and lease loss divided by total deposits, a performance ratio (FDIC,

2005a).

Net operating income to assets (NOIJY). Net operating income to assets is net

operating income divided by average assets, a performance ratio (FDIC, 2005a).

Retained earnings to average equity (ROEEINJR). Retained earnings to average

equity mean net income less cash dividends divided by average equity, a performance

ratio (FDIC, 2005a).

Return on asset (ROA). Return on asset is net income after taxes and

extraordinary items divided by average assets, a performance ratio (FDIC, 2005a).

Return on equity (ROE). Return on equity is net income after taxes and

extraordinary items divided by average equity, a performance ratio (FDIC, 2005a).

Tier 1 risk-based capital ratio (RBC1RWAJ). Tier 1 risk-based capital ratio is Tier

1 (core) capital divided by the risk-weighted assets. Within this definition, the appropriate

regulator that is subject to market conditions defines risk-weighted assets a capital ratio

(FDIC, 2005a).
27

Total risk-based capital ratio (RBCRWAJ). Total risk-based capital ratio is total

risk-based capital divided by the risk-weighted assets, a capital ratio. Within this

definition, the appropriate regulator that is subject to market conditions defines risk-

weighted assets a capital ratio (FDIC, 2005a).

Yield on earning assets (INTINCY). Yield on earning assets is the annualized total

interest income divided by the average earning assets of the bank, a performance ratio

(FDIC, 2005a).

Logistic Regression Analysis Terminology

The application of logistic regression to analyze the collected data facilitated

completing the predictive aspect of the study. Logistic regression is a regression

methodology that predicts or explains a binary nonmetric dependent variable by

determining the likelihood of the independent variables influencing the dependent

variable (Hair, Black, Babin, Anderson, & Tatham, 2006). Logistic regression analysis

has unique terms that will be used in subsequent chapters and are defined as follows:

Likelihood ratio test. The likelihood ratio in logistic regression is a measure of

model estimation fit and is measured as -2 times the log likelihood (-2LL) (Hair et al.,

2006). The log likelihood ratio test is a test of model fitness. The test measures the level

of difference between the -2LL for the study model and the -2LL for a reduced model

(Garson, 2006).

Log likelihood (LL). The log likelihood in logistical regression is the probability

of the value of dependent variable that is predictable from the value of an independent

variable (Garson, 2006).


28

Maximum likelihood estimation (MLE). In logistic regression analysis, the

coefficients of the independent variables are estimated using an iterate algorithm. Instead

of minimizing the squared deviations as in linear regression, logistical regression permits

to maximize the likelihood of an event occurring (Hair et al., 2006). The MLE maximizes

the log likelihood (LL), which is the likelihood that the dependent variable may be

predicted from an independent variable (Garson, 2006).

Assumptions

Several assumptions applied to the current study. It was assumed that the financial

data collected by the FDIC and the individual community banks’ independent auditors

were accurate and a true reflection of the financial condition of the banks. It was assumed

that the finding of personal dishonesty of an individual in the termination or prohibition

order issued by the FDIC was true and factual. While the FDIC makes efforts to ensure

accuracy of the data it collects, the agency issues a disclaimer that it cannot guarantee the

comprehensiveness or completeness of its database of enforcement actions or the

complete accuracy of the financial data (FDIC, 2006).

Another assumption was the similarity of operating conditions between banks.

Matching banks by geography, size, and time assumes that they operate in similar

economic conditions. Advances in technology and communications can allow banks to

employ differing operating strategies and serve nonlocal customers. Such a situation

would negate the control variables and the attempt to match economic operating

conditions, rendering the assumption false.

Logistical regression analysis assumes all relevant variables are included in the

model and all irrelevant variables are excluded of the model (Garson, 2006). Error terms,
29

(i.e., false positive and false negative results) were assumed independent. Cases that were

not missing and a low measurement error existed.

A linear relationship was assumed between the independent variable and the log

odds of the dependent variable. The log odds were defined as the natural log of the odds

of the dependent variable occurring (Garson, 2006). Logistical regression assumes that

there is no multicollinearity between independent variables. Logistical regression also

assumes no outliers are in the data and that the expected dispersion of the variance of the

dependent variable and the actual dispersion are small.

Limitations

All studies have limitations or weaknesses that affect the degree of generalization

of findings (Creswell, 2003). A common limitation in studies involving fraudulent

behavior is that only discovered frauds can be the subject of research. When selecting a

matching no fraud bank, the selection can include a bank where a fraud has occurred that

was not discovered. The selection of a matching community bank for the study involved

scrutiny of the matching bank for 3 years subsequent to the matching date to determine

whether a fraud had occurred subsequently to the selection.

A second limitation was that the study population did not include all community

banks but only banks insured by the FDIC. Credit Unions, not insured by the FDIC,

provide many of the same services to a local community as community banks insured by

the FDIC. Institutions such as mortgage bankers and finance companies also provide a

limited number of services that FDIC-insured community banks provide and were not

included in the study. No claim is made about the generalization of the results to banking

institutions not insured by the FDIC.


30

Logistical regression analysis has limitations; the reliability of maximum

likelihood estimate (MLE) decreases as the sample size decreases, and the reliability of

the MLE increases as the sample size increases. The convergence process of the MLE is

dependent on an adequate sample size (Garson, 2006). The adequacy of the sample can

be a limitation on the effect of the goodness of fit measures.

Delimitations

Only community banks insured and regulated by the FDIC participated in the

study. The focus was limited to three groups of financial ratios (i.e., performance,

growth, and capital) as indicators used by the FDIC in assessing the financial condition of

community banks. Data collected by the FDIC provided the ratios. Only a limited form of

fraudulent behavior as detected by the FDIC was the selection criterion for the fraud

participants. The fraud participants were matched to no fraud participants of similar asset

size, location, during the same periods.

Summary

The purpose of the quantitative correlation study was to examine the relationship

between the occurrence of management fraud in community banks in the United States

and financial ratios the FDIC uses to monitor the banks’ safety and soundness. Earlier

research by the OCC (1988), USGAO (1994), and the FDIC (1997) indicated a potential

link between the occurrence of management fraud and financial failure. When managers

and leaders defraud stakeholders who trust them with managing and leading an

organization, the potential damage is grave. Management fraud in a bank undermines the

trust developed with bank stakeholders.


31

Community banks represent an important subset of banking institutions that

provide banking services to small businesses as well as rural and agricultural economies

(Critchfield et al., 2004). The FDIC administers the depository insurance fund

guaranteeing the public’s deposits with insured banks and acts as the regulator for the

safety and soundness of most community banks (FDIC, 2005b). The FDIC collects

financial statement data, including financial ratios, and monitors community banks to

detect distress and possible failure. Financial ratios created from financial statements are

successful indicators of the probability of financial failure in banking and nonbanking

organizations (Altman, 1983; FDIC, 2007a). The current study was the examination of

financial ratios used by the FDIC as indicators of the financial condition of a community

bank and the potential relationship of financial ratios to the occurrence of management

fraud.

Chapter 2 is a review of historic and current literature pertinent to the occurrence

of management fraud, its causes, detection, and prevention. A discussion of the predictive

attributes of financial ratios and the banking industry follows the sections on management

fraud. The review follows an organizational pattern with sections on (a) management

fraud, (b) organizational decline, and (c) the banking industry.


32

CHAPTER 2: LITERATURE REVIEW

Management fraud is an interdisciplinary research topic. Many theories in

finance, organizational behavior, ethics, accounting, management, social psychology, and

leadership address various aspects of management fraud. Few researchers have directly

studied the underlying causes of fraudulent acts by management (Smith et al., 2006).

Management fraud takes many forms, including intentionally removing or

misstating the assets or obligations of an organization (Elliot & Willingham, 1980). The

unfortunate results of such removals or misstatements can be the failure of the

organization. The focus of the study was community banks, specific financial ratios used

by the FDIC as indicators of the financial condition of community banks, and the

relationship of the indictors to management fraud.

Documentation

The study of improper, illegal, and fraudulent behavior on the part of managers,

leaders, and organizations has produced a variety of perspectives because of its relevance

to many different disciplines such as criminology, accounting, finance, psychology,

sociology, ethics, economics, and law (Zahra et al., 2005). The topics of organizational

decline and the world of financial institutions are as interdisciplinary as the topic of fraud

by leadership. Management fraud, organizational decline, and banking have rarely been

studied together, requiring a review of far more literature than is incorporated in the

current study.

A summary of the literature incorporated in the study is shown in Table 2. The

study includes 95 of the 100s of journal articles, dissertations, Web sites, books, and

reports reviewed. Eighty-four sources are incorporated into the literature review, and 10
33

of the 84 are related to research methods, designs, and analytical techniques. The

literature review consists of three theoretical concepts and search topics that are (a)

management fraud, (b) organizational decline, and (c) banking. Journal articles constitute

the largest segment of the literature with 30 articles on management fraud, 7 articles on

organizational decline, and 19 articles on banking.

Table 2

Summary of Literature Review

Theoretical concepts Journal Dissertations Web sites Books and

and search topics articles reports

Management fraud 30 1 2 11

Organizational decline 7 0 0 1

Banking 19 0 9 4

The research of deviant, abusive, or illegal behavior by management has produced

a multitude of constructs and definitions (Griffin & Lopez, 2005). Management fraud has

represented a small portion of research that is fragmented into the issues of corporate

governance, accounting and auditing, and criminology. The two germinal works of

Sutherland (1973) and Cressey (1971) have formed the foundations of thought in the

study of management fraud, but Smith et al. (2006) noted there have been few empirical

studies in the area of management fraud. The corporate governance literature focused on

management fraud (Schnatterly, 2003) produced conflicting results (Beasley et al., 2000;

Griffith et al., 2002).

The current study was an examination of financial ratios used by the FDIC as

predictors of occurrence of management fraud, the dependent variable in the study. The
34

AICPA (2005) recommended that auditors use analytical procedures such as financial

ratios to detect fraud. While auditors have and continue to follow the recommendation,

there is little empirical evidence that financial ratios can detect fraud (Kaminski et al.,

2004).

Extensive research on performance in the corporate world is available, but there

are far fewer studies in the banking industry (Griffith et al., 2002). The primary studies

concerning bank failures by the OCC (1988), USGAO (1994), and FDIC (1997) have

indicated a potential link between management fraud and failure. The U.S. banking crisis

in the 1980s and 1990s instigated research, and federal agencies conducted the studies.

An extensive search of all regulatory Internet sites, journals, and working papers for

recent scholarly works on bank failures or management fraud took place, and documents

on only a few bank failures were found.

Historical Overview

Recent headlines have been full of accusations and accounts of executives

committing management fraud. Enron, WorldCom, Tyco, Adelphia, Cendent, Rite Aid,

Sunbeam, Waste Management, Health South, Anderson, Ernst & Young, KPMG

International, Deloitte & Touche, Price Waterhouse, Coopers, J. P. Morgan, Merrill

Lynch, Morgan Stanley, Bear Sterns, Salomon Smith Barney, Parmalat, Global Crossing,

and Credit Suisse First Boston have all been fined, implicated in, or convicted of criminal

behavior, or they have admitted guilt to unethical practices (Anand et al., 2004; Duska,

2004; Ivancevich, Duening, Gilbert, & Konopaske, 2003). The list is a current list of

companies with management misbehavior that the news media has reported. Each year,

the list continues to grow despite efforts to reduce management fraud.


35

Along with boards of directors, managers are responsible for fraud prevention and

detection and for promoting honest and ethical behavior in U.S. organizations (AICPA,

2005). Some types of fraud, particularly financial reporting fraud, start with executives

such as the chief executive officer (CEO) or the chief financial officer (CFO) (COSO,

1987). While the majority of financial and business people are as ethical and industrious

as in any other segment of the workforce, society faces the tragic occurrences of leaders

and managers committing unethical or possibly criminal acts. The recognition, detection,

and elimination of such behavior are essential because management fraud seriously

damages or destroys organizations.

The banking industry has traditionally occupied a unique position within the

economy of the country because of the special role it plays in facilitating payments and

channeling credit to individuals and businesses (Samolyk, 2004), making poor financial

condition in the banking industry a major issue for owners, the public, and management

(Simpson & Gleason, 1999). The ultimate result of continued poor financial condition by

a bank is failure. An unfortunate result of management fraud can be the failure of an

organization. Several studies of the banking crisis in the 1980s and 1990s have indicated

a relationship between fraud by insiders and financial failure of a bank (FDIC, 1997;

OCC, 1988; USGAO, 1994).

The banking crisis of the late 1980s and early 1990s illustrated the convergence of

financial institutions, financial performance in organizations, and the occurrence of

management fraud (FDIC, 1997; OCC, 1988; USGAO, 1994). Historically, the topics of

organizational financial performance and management fraud have remained separate

within the theoretical frameworks of the appropriate disciplines. Multiple definitions for
36

the same terms within research of multidisciplinary topics makes direct comparison to

individual studies difficult.

Sutherland first coined the phrase white-collar crime in the 1940s. White-collar

crime is a term that changes common and legal definitions by identifying a specific class

of wrongdoers (Sutherland, 1973). Position and social status, not demographics,

differentiate the term white-collar crime from other types. The position white-collar

criminals hold, not the act itself, defines the term (Sutherland, 1973). Sutherland believed

the same basic variables that prompted ordinary criminal behavior prompted white-collar

crime. According to diffusion theory (Sutherland, 1973), individuals who support or are

exposed to criminal activity and are not exposed to counterinfluences accept criminal

behavior.

In one of the earliest studies of management fraud, Cressey (1971) interviewed

133 convicted embezzlers who held management positions at the time they committed the

criminal acts. From the interview data, Cressey hypothesized that management fraud

occurred because of the presence of the following three elements: (a) an unsharable

financial problem, (b) the accessibility and control of assets or accounting records, and

(c) the ability to rationalize the actions the fraudster takes. Cressey’s contention was that

viewing management fraud purely from a point of control and regulation was incorrect

and that the study of management fraud needed a behavioral context (Cressey, 1971).

There is extensive research on the causes and predictability of financial distress,

and many predictive models have been developed (Altman, 1983). According to Altman,

there can be many causes for financial distress, including microeconomic and
37

macroeconomic factors. Analysis of such factors can provide insight into the types and

levels of financial distress within organizations.

The OCC (1988) conducted an analysis of failed national banks under its

regulatory oversight following the banking crisis of the 1980s. The OCC findings

revealed that 90% of bank failures resulted from poor management and almost one third

included fraud by the bank’s management. A study by the USGAO (1994) of 286 banks

that failed in 1990 and 1991 found insider abuse, insider fraud, or loan losses to insiders

in 61% of the failed banks. A study by the FDIC (1997) of banking institutions subject to

the FDIC supervision during the years 1980 to 1994 found management fraud was a

significant contributing factor in the failure of a large percentage of failed financial

institutions.

Community banks are banks with less than $1 billion in assets and account for

94% of the number of institutions within the banking industry (Critchfield et al., 2004).

In the years 1998 to 2002, community banks represented a disproportionate share of

losses to the FDIC. During that time, community banks represented 63% of failed bank

deposits insured by the FDIC and 72% of the failure costs. The higher costs of the impact

of bank failure for community banks and the implied relationship between bank failure

and fraudulent management activity are causes for concern.

Management Fraud

Elliot and Willingham (1980) defined management fraud as a “deliberate fraud

committed by management that injures investors and creditors through materially

misleading financial statements” (p. 4). A manager is a person who controls or is beyond

the control of internal safeguards within an organization. In defining this aspect of


38

management misbehavior, Elliot and Willingham described a confluence of activities that

occur within the business environment, business crime, misleading financial statements,

and management activity.

Business crime is all illegal business activity, internal and external to the

organization. Misleading financial statements are the conventions, intentional acts, and

unintentional acts that lead to misunderstanding a financial statement. Management

activity refers to the actions managers take in the course of business. Elliot and

Willingham (1980) noted these activities combined to increase the risk severity to the

organization and the culpability of management.

Corporate fraud is a view of fraud from the perspective of the object of the fraud

(O’Gara, 2004). In that context, it can be either for the organization (i.e., inflating sales)

or against the organization (i.e., hiding or diverting assets). Since all fraud by

management reflects an overstatement, understatement, or misstatement within the

financial reporting structures, O’Gara defined corporate fraud as the abuse for personal

gain of the opportunities and authority the position of management provides.

The term occupational fraud refers to “the use of one’s occupation for personal

enrichment through the deliberate misuse or misapplication of the employing

organization’s resources or assets” (Association of Certified Fraud Examiners [ACFE],

2004, p. 1). Within the ACFE definition is a subset of occupational fraud that includes

owners and executives. ACFE stated in their biannual report on occupational fraud that

owners and executives represented only 12.4% of all reported cases of occupational fraud

but with a median loss 14 times larger than losses from nonexecutives.
39

Notwithstanding the enactment of the Sarbanes-Oxley Act of 2002 by the United

States Congress and its requirements of increasing organizations’ internal controls to

detect and prevent management fraud, the ACFE 2004 Report to the Nation on

Occupational Fraud showed only 6% of all cases of occupational fraud by owners and

executives were discovered by internal controls. Unsolicited reports of misbehavior by

those not involved with internal controls uncovered the majority of cases (51%).

Accountants and auditors view management fraud through the lens of their

responsibilities in the preparation and certification of the financial statements prepared

from the organizations books and records. The AICPA (2005) provides guidance to

accountants and auditors regarding their duties in the detection and prevention of

management fraud. The Financial Standards Accounting Board provides standards

regarding the prevention and detection of management fraud.

Subsequent to the passage of the Sarbanes-Oxley Act of 2002, Statement on

Accounting Standards [SAS] 99 revised the standards and methods that auditors used to

provide management fraud detection to clients. The changes in SAS 99 required auditors

to be increasingly proactive in the prevention and deterrence of management fraud. The

change was a departure from previous standards that focused on the detection of

management fraud (Marczewski & Akers, 2005).

Sutherland (1973) proposed a diffusion theory of fraudulent behavior and stated

that white-collar crime was a learned behavior from those who promoted it in the absence

of those who rejected it. Baker and Faulkner (2003) used the term intermediate fraud to

describe organizations created for a legitimate purpose that began, at some stage, to

engage in illegal activities. Using a case study of an oil and gas venture that began as a
40

legitimate business venture before adopting fraudulent behavior, Baker and Faulkner

applied diffusion theory in analyzing the transition from legitimate to illegitimate

enterprise. Baker and Faulkner concluded the factors that contributed to the success of the

organization were common to legal or illegal activities.

Management fraud requires a deliberate act of financial manipulation that results

in a material misrepresentation of the financial statements of the organization. The

fraudulent act can be direct manipulation of the accounting records or concealing by false

accounting entries (Elliot & Willingham, 1980). According to Saunders (1980),

“Management fraud can, in many instances, be conceptualized as merely a perversion of

effective management behavior” (p. 108). The financial incentive compensation system

rewards those who aggressively exploit profitable opportunities (Jensen, 2004). The

system has, at times, the effect of encouraging managers to cross the line between ethical

and unethical behavior.

The Causes of Management Fraud

Cressey’s (1971) original work in analyzing managers who embezzled from the

organizations that employed them found management fraud to include three elements: (a)

an unsharable problem, (b) accessibility and control of assets or accounting records, and

(c) the ability to rationalize the actions they took. Cressey described a triangular

relationship between opportunity, pressure, and rationalization (Wells, 2001; Wilson,

2004). Opportunity refers to the ability to bypass or override controls meant to prevent

manipulation. Pressure is the motivation to commit the fraudulent act, and rationalization

refers to the moral and ethical argument used to justify the act (Wilson, 2004).
41

While Cressey’s (1971) triangular model provides a basis for understanding

management fraud, other factors are present in many situations in which managers

engage in fraudulent activities. Ludwig and Longenecker (1993) described a phenomenon

they termed the Bathsheba syndrome. Managers and leaders who are increasingly

successful often acquire unrestrictive control over the organization and its resources.

The Bathsheba syndrome is described in the Book of Samuel in the Bible in which the

story of David and Bathsheba is an example of the corrupting influences of power and the

willful abuse of authority. As a successful leader and warrior, David is granted increasing

authority over the people of Israel. David abuses his authority in seducing Bathsheba and

his attempts to cover-up this indiscretion leads to the death of Bathsheba’s husband.

Ultimately, David’s abuses are discovered, he is disgraced, and performs public penance.

Ludwig and Longenecker (1993) suggested that a negative consequence of success is the

new ability of managers to rationalize actions they know are unethical. Several studies

conducted after large organizational failures have shown higher than anticipated

involvement of senior management in covering up or causing the causes of decline

(COSO, 1987).

Managerial Discretion

Some theories of management behavior have been grouped under the general

concept of management discretion to explain the failure of large organizations such as

Enron, Maxwell Communications, and Polly Peck (Barnes, 2004). The presence of

management fraud in such circumstances could be expected if explained with the concept

of management discretion in which stakeholders rely upon management to use its

discretion in making decisions (Barnes, 2004). Meckling and Jensen (1976) suggested
42

that, rather than pursue shareholder goals, managers pursue their own interests. When a

firm is in financial distress, management’s interests are threatened, leading management

to take steps that conflict with stakeholder interests to forestall the failure of the

organization and save their interests (Barnes, 2004).

Another form of management discretion is hubris theory (Barnes, 2004). The

hubris theory of management behavior predicts that success causes managers to believe

that their judgment is superior to that of all others with the effect of producing

overconfidence in management’s decision making. When management discretion moves

to create a conflict of interest with stakeholder interests, it creates what Barnes called

managerial diversion. In managerial diversion, managers divert resources of the

organization for their own use. Managers often resort to diverting resources in order to

forestall failure or conceal mistakes in managerial discretion. Shareholders and

stakeholders detect managerial diversion primarily through audited financial statements

(Barnes, 2004).

Ethical Behavior

Underlying or deeply held beliefs and attitudes can affect ethical decision making.

Cynical beliefs and unethical behavior are related (Traynor, 2004). Traynor studied

graduate and undergraduate students and found those who held the belief that most

people cheat and steal were far more likely to cheat and steal. Through a series of studies

using ANOVA and logit regression to test cynical beliefs and differing unethical

behaviors, Traynor found that cynicism was a predictor of unethical behavior. Traynor

concluded the belief that others are acting unethically provides a rationalization for

people to act unethically.


43

The rationalization of unethical conduct within organizations exists when others

perceive managers to be unethical or to condone unethical behavior (Anand et al., 2004).

Anand et al. found that rationalization of unethical behavior leads to a socialization of

such behavior. The cycle of rationalization and socialization spreads behavioral standards

through the organization, supporting and perpetuating behavioral tendencies.

The factors that influence managers’ unethical or fraudulent behavior are elusive.

Williams et al. (2000) studied relationships of managerial education and earlier

experiences with corporate wrongdoing. Williams et al. examined the top management

teams and boards of directors from Fortune 500 firms for the period 1991 to 1994. The

definition of illegal activities was violations of Occupational Safety and Health

Administration (OSHA) and Environmental Protection Agency (EPA) regulations.

In Williams et al.’s (2000) study, the violations served as the dependent variable,

and military service and graduate education of top management, firm size, and firm

strategy were independent variables. Firm strategy indicated no link with illegal activity.

Citations for illegal activity increased with firm size. As citations for illegal activity grew

with firm size, so did the level of military service of top management teams. Illegal

activity at large firms increased with the level of graduate education of the top

management team. The causal relationship between such factors is not evident. Williams

et al. (2000) speculated that military service and education might reflect yet unknown

variables.

Institutional Anomie Theory

Cullen et al. (2004) studied managerial ethical reasoning under conditions of

institutional anomie. According to institutional anomie theory, cultural and institutional


44

factors influence decision making by changing the focus of attention from group or social

principles to individualistic or egocentric considerations (Messner & Rosenfeld, 2001).

Cullen et al. used data the World Values Study Group (2005) had collected from 3,450

managers in 28 different countries. The dependent variable was a manager’s willingness

to justify ethically suspect behavior, and the independent variables were national culture

and social institutions. Cullen et al. found that conditions of institutional anomie affected

managerial personnel differently than the general population, based on results of previous

studies of the general population. Cullen et al. speculated that the social status attached to

the manager’s position changes the effects of cultural and institutional factors in the

ethical decision-making process.

Agency Theory

Agency theory predicts a change in management behavior as the goals of

managers diverge from the goals of stockholders (Jensen, 2004). Jensen stated that the

failure of firms such as WorldCom and Enron had at its roots agency costs. An agency

relationship occurs whenever shareholders hire managers to run an organization (Jensen,

2004).

According to agency theory, managers have their own interests at heart. Agency

costs are the costs associated with monitoring management’s activities and preventing

conflicts of interests. Agency costs are associated with attempts to control management

behavior (Ekanayake, 2004). The use of incentives, compensation schemes, and control

mechanisms affect management’s behavior and the alignment of their interests with

shareholders.
45

Management Fraud Detection

In October 2002, the AICPA auditing standards board released SAS 99 entitled

Consideration of Fraud in a Financial Statement Audit. The new standard provides

guidance to the auditing industry for detecting financial statement fraud (Thomas &

Gibson, 2003). An enclosed document to the statement is Management Antifraud

Programs and Controls. In the document, the AICPA outlined an approach to the

detection and prevention of material financial statement fraud that included (a) a culture

of honesty and high ethics, (b) antifraud controls, and (c) oversight (AICPA, 2005).

Ivancevich et al. (2003) proposed a comprehensive program to deter white-collar crime

and reform the excesses of the recent past. Using Sutherland’s (1973) definition of white-

collar crime, Ivancevich et al. proposed (a) the elimination of accounting industry

conflicts of interest, (b) increased sentencing for white-collar crime, (c) administration

and civil sanctions, (d) financial penalties, (e) shaming offenders, (f) a national code of

conduct, (g) ethical behavior rewards, (h) independent board members, (i) a governance

institute, and (j) board member evaluations.

While AICPA guidelines provide a basis for evaluation, the methodology used to

implement the guidelines can affect their effectiveness. Kaminski et al. (2004) studied a

technique called ratio analysis auditors use to determine whether financial statements

contain material misstatements. Kaminski et al. conducted a longitudinal study of 21

financial ratios that auditors commonly use in analyzing the possibility of financial

statement reporting fraud. In comparing financial statements from fraudulent and

nonfraudulent companies, Kaminski et al. found ratio analysis had limited ability to

detect a fraudulent reporting firm from a nonfraudulent reporting firm. Sixteen of the
46

financial ratios were found to be significant, but few were significant over multiple

periods. A very high rate of misclassifications was evident, ranging from 58% to 98%.

The lack of theoretical backing for the financial ratios used in the analysis might explain

the problem (Kaminski et al., 2004).

Smith et al. (2006) observed the effects of the threat of formal sanctions on the

ethical conduct of managers. After each wave of corporate wrongdoing, such as the

recent scandals of Enron and WorldCom, governmental and regulatory agencies enact

penalties and sanctions to act as deterrents for future misconduct. Criminologists employ

deterrence theory to explain the decision-making process in unethical behavior. In

deterrence theory, the cost of being caught is weighted against the perceived benefits of

the unethical activities. Smith et al. found the formal sanctions were not directly

influencing behavior. Informal sanctions from society that affected the managers’ image

within their community or family were the most effective deterrents.

Management Fraud Prevention

Beasley et al. (2000) examined the differences in corporate governance

mechanisms between organizations that were guilty of financial reporting fraud and those

that were not. Unlike previous researchers, Beasley et al. segmented the organizations by

industry concentrations, technology, healthcare, and financial services. Beasley et al.

used allegations made by the Securities and Exchange Commission (SEC) during the

period 1987 to 1997 of fraudulent financial reporting to establish fraud organizations and

data from the National Association of Corporations (NACD) to match the fraud

organizations and establish a no fraud company comparison base. Beasley et al.’s

findings indicated that organizations found guilty of financial reporting fraud (a) had less
47

independent boards, (b) had fewer audit committees, (c) the audit committees met less

often, (d) the audit committees were less independent, and (e) the boards and audit

committees had less internal audit support.

Griffith et al. (2002) examined management ownership and financial performance

in 100 bank holding companies during the period 1995 to 1999. Griffith et al. used the

financial indicators of economic value added, market value added, and Tobin’s q to

evaluate financial performance. The findings indicated that CEO ownership improved

performance when ownership was less than 12% or over 67%. When financial ownership

was in the midrange, performance decreased.

Griffith et al. (2002) posited there were points at which CEO ownership interacted

with personal wealth diversification leading to the choice of a less risk-tolerant position.

Griffith et al. found the combination of the positions of CEO and chairman of the board

of directors had no effect on financial performance. The finding differs from that of

Beasley et al.’s (2000) who had found board independence and the separation of the CEO

and chairman of the board positions significant.

Crutchley et al. (2007) examined corporate governance characteristic at firms that

suffered accounting frauds during the period 1990 to 2003. Fraud firms were matched to

no fraud firms by Standard Industrial Classification (SIC) codes and markets values

determined by book value to market value ratios. Crutchley et al. found that certain

characteristics increased the likelihood of a firm being involved in an accounting scandal.

The characteristics included (a) high levels of growth, (b) engaging in earnings

management techniques, (c) audit committees composed of few outside directors, and (d)

overextended outside directors.


48

Organizational Decline

Since Altman’s (1983) original work on predicting the probability of

organizational decline or failure, many proprietary models have been developed to assist

in credit-making decisions. Researchers have linked organizational decline or failure to

the increased likelihood of management fraud. Lemke and Schminke (1991) examined

the relationship between the two variables of unethical behavior and declining

organizations, contending that decline of an organization was the controlling variable.

Lemke and Schminke (1991) proposed two hypotheses. In the first hypothesis, a

declining organization will show a higher level of unethical behavior than an organization

not in decline, and the greater the decline, the greater the level of unethical behavior. In

the second hypothesis, the effects of decline will be independent of the initial level of

unethical behavior in an organization. Conducting studies with direct experimentation

with managers placed in unethical dilemmas raises ethical concerns, so Lemke and

Schminke used scenario simulation. The simulation created industry-wide conditions that

placed the participating teams into stages of financial decline and provided options of

questionable ethical behavior at various points in time. The conclusions reached in the

study confirmed both hypotheses and suggested further study into potential other factors

(e.g., organizational environment, structure, leadership style, culture) that affect ethical

behavior.

Corporate Failures

Altman (1983) conducted extensive research of the causes and predictability of

financial distress and influenced the development of many of the predictive models in use

today. While macroeconomic factors influence individual organizational distress, the


49

primary factors that cause financial distress lie within the organization itself (Altman,

1983). Analysis of such factors can provide insight into the types and levels of financial

distress within an organization.

In the development of the z score model, Altman (1983) examined 66 matched

pairs firms using financial ratios as dependent variables predictors of financial failure.

The subsequent testing of the z score model showed success for up to two reporting

periods before the failure. The accuracy of the model decreased quickly as the duration of

the period under study expanded. Subsequent models refined the accuracy of prediction.

The models are not publicly available since they are proprietary property of organizations

engaged in the financial data reporting business.

D’Aveni (1989) conducted a longitudinal study to examine different patterns of

decline in organizations and how the patterns affected decision making. Three different

patterns of decline were identified that were (a) gradual decliners, (b) sudden decliners,

and (c) lingerers. Using a matched pairs study design, a total of 98 large firms were

selected and matched by environment and size, one being bankrupt and the other being

survivors, a term which was not defined. Four decision variables tested for a correlation

to the patterns of decline, strategic, managerial, environmental, and size. The

determinants for the variables were obtained from public information, such as merger

activity, research and development budgets, liquidating of assets, and centralization of

management.

D’Aveni’s (1989) study produced a new definition of decline by incorporating a

time element. D’Aveni confirmed and expanded the concept of resource munificence by

including financial resources and managerial resources. D’Aveni concluded that strategic
50

and managerial consequences of a declining firm created managerial imbalances with

more managers dealing with survival than with growth. One of the weaknesses in the

study was that it only included large firms. The factor of size might have an overall

impact on the availability of resources, particularly as size relates to the ability to

liquidate and downsize operations. D’Aveni did not attempt to examine the

characteristics prevalent among firms that recovered from decline and what actions the

firms took to recover.

Banking Failures

Gupta and Lalatendu (1999) studied the large number of bank failures during the

1980s and 1990s through the examination of regulatory and academic studies focusing on

causes. From the analysis, Gupta and Lalatendu constructed recommendations for a new

regulatory structure for the banking industry. The study included five parts that explored

(a) the origins of the banking crisis, (b) how the Savings and Loan regulators originally

handled the crisis, (c) how the crisis was handled after the passage of the Financial

Institution Reform Recovery and Enforcement Act (FIRREA), (d) how the Federal

Deposit Insurance Company (FDIC) handled the crisis, and (e) changes in the regulatory

system since the passage of the Federal Deposit Insurance Company Improvement Act

(FDICIA).

Gupta and Lalatendu (1999) drew from other studies and concluded that

macroeconomic conditions were the root causes of the banking crisis (e.g., erratic public

policy, insufficient oversight by regulators). Gupta and Lalatendu recommended higher

capital, deposit insurance reform, and increased regulatory monitoring including limited

flexibility for regulatory interpretation. Most notably missing from the study was any
51

mention of three major studies and investigations by government sponsored agencies, one

by the OCC in 1988 and two by the USGAO in 1993 and 1994.

Wheelock and Wilson (2000) studied the question of U.S. banks disappearing

through failure or acquisition. Because banking is still a highly regulated industry,

regulatory barriers and restrictions influence economic dynamics. Using a hazard model,

Wheelock and Wilson focused on performance indicators as determinants of failure and

the likelihood of acquisition by another institution. Wheelock and Wilson found that the

lack of capitalization, high leverage, poor asset quality, and low profitability were key

determinants of whether a bank would fail. The same factors were key determinants of

whether banks would be acquired.

Cebula (1999) studied bank failures from 1963 to 1991 and concluded that

regulatory actions such as capital requirements, changing competitive environment, and

deposit insurance had a major impact on failures. Cebula believed the impact was

particularly real when factoring economic trends such as interest rates and domestic

growth into the analysis. Cebula suggested that increasing the level deposit insurance

contributed to bank failure rates during the period studied.

Simpson and Gleason (1999) examined the effect of ownership and board

structure within banks in financial distress. The type of oversight of management is the

responsibility of owners or their assigned representatives including the board of directors.

Simpson and Gleason used information from publicly traded companies that financial

data analysis organizations scrutinize. According to Simpson and Gleason’s conclusions,

the closer management was involved within the board, the less likely the bank would be

in a position of financial distress. Simpson and Gleason’s finding seems to be contrary to


52

Beasley et al.’s (2000) contention that greater board independence decreased financial

distress.

Lee (2002) posited a relationship existed between the risk-taking propensity of

bank managers, the size of the institution, and management ownership in the institution.

In the study of 65 bank holding companies during the period of 1987 to 1996, Lee found

that large stockholder-controlled institutions, as opposed to management-controlled, were

greater risk takers. Lee posited the probability of organizational failure was lower in

management-controlled institutions. Managers’ goals and incentives more closely align

when the risk of organizational failure is lower.

Curry, Elmer, and Fissel (2001) studied the effects of market data as predictor of

financial distress in banks. Curry et al. found that measures of stock prices and returns on

publicly traded banks exhibited indicators of distress 2 or 3 years before regulatory

downgrades were official. The trends did not hold true for improving banks and other

types of market data such as trading volume, and turnover of shares were not predictive.

The Banking Industry

Overview

According to Benston (2004), banks are interesting research environment because

banks have common products in loans, deposits, and checking accounts, and they have

readily collectable data provided by regulators. The data are standardized, available over

a long time horizon, and comparable. The banking industry in the United States has four

federal regulators, the FDIC, the FRS, the OCC, and the OTS.

Each regulator has supervisory responsibility for specific classes of banking

institutions. The FRS supervises bank holding companies such as state chartered banks
53

that are members of the Federal Reserve System, Edge Act banks, and branches,

agencies, and offices of foreign banks in the U.S. (FRS, 2007). The OCC supervises

national chartered banks, the FDIC supervises state chartered banks not in the Federal

Reserve System, and the OTS supervises Savings Associations insured by the FDIC

(OTS, 2007).

The U.S. banking system is a bifurcated system consisting of very large complex

institutions focusing on transactional banking and numerous small simpler institutions

acting on a banking relationship basis. While such descriptions are broad, they represent

generalizations of the activities of the U.S. banking industry (Anonymous, 2003). The

Federal Reserve has scrutinized large complex banking organizations since the early

1990s. Large institutions grow beyond the traditional banking products of deposits and

lending and service the economy with many innovative activities.

Regulators must approach large banking institutions in a different and more

comprehensive manner than other institutions. Unlike the smaller community or regional

banking organizations, the failure of one of the large complex banking organizations

poses a systemic danger to the banking system. The Federal Reserve, in conjunction with

the other regulatory agencies, has developed a continuous supervisory process

emphasizing internal systems and controls within the organizations. In 1999, the Federal

Reserve developed a basic framework for all complex banking organizations with over $1

billion in assets (DeFerrari & Palmer, 2001).

State and federal regulators monitor banks that do not fall within the definition of

complex banking organization through a series of onsite and offsite examinations (Collier

et al., 2003). The FDIC, in conjunction with other regulators, monitors institutions
54

covered by deposit insurance. As the insurer protecting deposits at member banks, the

FDIC has a regulatory responsibility for most banks in the United States.

The FDIC fulfills its obligation by conducting examinations of insured institutions

and taking enforcement actions when deemed necessary. Part of the examination is the

assignment of a safety-and-soundness rating based upon the areas of (a) capital adequacy,

(b) asset quality, (c) management, (d) earnings, (e) liquidity, and (f) sensitivity to market

risk (Curry et al., 1999). The FDIC uses such ratings in its regulatory duties, and the

information is sensitive and not publicly available.

A key component of FDIC oversight is a quarterly publication entitled the Call

Report. The Call Report contains detailed financial and demographic information (FDIC,

2005a) and is the basic regulatory information collection method for banks. In addition to

the role of collecting and monitoring financial data from all insured depository

institutions, the FDIC is the primary federal regulatory for state chartered institutions that

are not part of the Federal Reserve System (FDIC, 2004).

In the role of primary federal regulator, the FDIC can take both formal and

informal enforcement action against the institutions it supervises. Informal actions take

the form of board resolutions and memoranda of understanding to make changes in the

operations and management of the institution. In more serious situations for which

informal actions are ineffective, the FDIC takes formal enforcement actions including

written agreements, cease and desist orders, termination or prohibition orders against

individuals, the removal of officers and directors of the institution, and monetary

penalties (FDIC, 2005c).


55

As shown in Table 3, the FDIC was the primary regulator for over 60% of

banking institutions in 2006. The OCC was the primary regulator of 19.8% of FDIC

insured institutions and a majority of the insured assets. While the majority of insured

assets are regulated by the OCC, the FDIC regulates substantially more banking

institutions.

Table 3

Breakout of Primary Regulator of FDIC Insured Banks (2006)

Federal Number of Percentage of Total Assets

Regulator Institutions Institutions (in millions)

FRS 902 10.4 1,406,487

OCC 1715 19.8 6,829,269

FDIC 5220 60.1 1,712,140

OTS 844 9.7 1,463,950

Total 8681 100 11,411,846

Note: Adapted from FDIC (2007a). Statistics on Depository Institutions. Retrieved March 17, 2007, from
http://www2.fdic.gov/sdi/main.asp

Over the period 1996 to 2006, the FDIC was the primary regulator of 58.6% of all

FDIC insured banks and thrifts. FDIC is the primary regulator for state chartered banks

not in the Federal Reserve System. As shown in Table 4, of the four federal regulators,

the FDIC is the majority regulator for banks under $1 billion in assets. While the number

of banking institutions is falling because of industry consolidation (Jones & Critchfield,

2004), the FDIC is regulating an increasing proportion of institutions with under $1

billion in assets.
56

Table 4

Banks Under $1 Billion in Assets-1996 to 2006

Year All FDIC Insured Banks FDIC as Primary Regulator

Number of Percentage of Number of Percentage of

banks < $1 banks < $1 banks < $1 banks < $1

billion billion billion billion

2006 8064 92.87 4959 61.50

2005 8228 93.16 4994 60.70

2004 8411 93.60 5045 59.98

2003 8632 93.93 5109 59.19

2002 8828 94.30 5166 58.52

2001 9093 94.48 5305 58.34

2000 9387 94.72 5437 57.91

1999 9698 94.85 5565 57.37

1998 9945 95.05 5696 57.27

1997 10413 95.37 5960 57.23

1996 10903 95.27 6202 56.88

Note: Adapted from FDIC (2007a). Statistics on Depository Institutions. Retrieved March 17, 2007, from
http://www2.fdic.gov/sdi/main.asp

Community Banks

Two primary characteristics of a community bank are the relative smaller size of

the institution and the concentration of its activities in a single community (Anonymous,

2003). Community banks are deposit-taking institutions that focus on lending to a

specific local economy and are small in terms of their asset structure (Hein et al., 2005).
57

The small size is an identifier for community banks. A total asset base of $1 billion or

less is a common level of differentiation.

While many researchers use a threshold limit as a defining factor, a threshold

limit does not address all the complexities associated with a community bank. The scale

of operations conducted by the bank influences its behavior in the marketplace (DeYoung

et al., 2004). DeYoung et al. offered a multidimensional definition of a community bank

that included a threshold of $1 billion in assets, a majority of its deposits locally raised,

domestically owned, a traditional product mix, and independent operations. Critchfield et

al. (2004) used a similar definition of a bank or thrift below $1 billion in assets that

confines its business activities to a geographically limited location. For the current study,

the definition of a community bank was any bank monitored by the FDIC with assets

below $1 billion.

The FDIC, as the primary federal regulator of banks with less than $1 billion in

assets, requires quarterly standardized financial statements that measure the financial

performance of a bank. The financial statements called Call Reports are required of all

insured banks. The FDIC is responsible for monitoring the safety and soundness of banks

it insures (FDIC, 2005c). A part of such responsibility, the FDIC monitors the financial

condition of the banks it insures.

The number of community banks has fallen by nearly half since the beginning of

1985, from 15,084 to 7,842 at the end of 2003, reflecting the changing banking

environment. The reduction in the number of community banks occurred largely from

failure and unassisted mergers. During the period 1985 through 2003, 8,122 banks were

merged, purchased, or acquired by other banking organizations, 2,698 failed, and 3,097
58

new banking organizations were formed (Jones & Critchfield, 2004). The successes of

the newly formed banking organizations suggest the viability of the community bank

model. Between 1992 and 2003, approximately 1,250 new community banks formed,

over 1,100 still exist independently, approximately 100 have been merged, 17 closed

voluntarily, and 4 failed (Critchfield et al., 2004).

While the aggregate number of banking institutions has been declining since

1985, the more recent trend is toward stabilization at present levels or a slight decline in

future years (Jones & Critchfield, 2004). For community banks, the shift has been away

from the very small institutions of $100 million or less. The reduction is mostly from

growth into the segment above $100 million rather than from failure or mergers and

acquisitions. Failure, mergers, and growth have all had an effect in changing the

community bank sector.

Indicators of Financial Condition and Management Fraud

Many indicators of organizational decline approximate the indicators auditors use

in fraud detection analysis. Apostolou, Hassell, Webber, and Summers (2001) examined

the fraud risk factors that auditors use in making a determination during an external audit.

Using the risk factors identified in SAS 88, Apostolou et al. surveyed 93 auditors from

large auditing firms and regional and local firms.

Apostolou et al.’s (2001) findings were that auditors viewed management

characteristics and control procedures as more important than operational and financial

characteristics. Apostolou et al. found that economic characteristics were the least

effective method of evaluating the risk factors of fraudulent activities. The conclusions

are the practitioners’ views rather than the results of a statistical study.
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Saksena (2001) examined environmental factors of financial performance,

insolvency, organizational slack, size, the environmental dynamic, a hostile environment,

heterogeneous environment, and industry membership and how such factors might relate

to management fraud. The foundational basis for using such factors is agency theory and

illegal corporate activity literature. The definition of management fraud used was a

formal complaint issued by the Securities and Exchange Commission for violating Rule

10(b)-5 and the filing of a fraudulent financial report.

Saksena (2001) conducted correlation analysis, univariate analysis, and logistic

regression of 152 matched paired, fraud and no fraud companies, for the period 1982 to

1993. Of the internal factors tested, financial performance, insolvency, slack, and size, all

showed a coefficient direction as predicted, but only size indicated a statistically

significant result. Of the external factors tested, dynamic environment, a hostile

environment, heterogeneous environment, and industry membership produced similar

results with the coefficients indicating the predicted direction but only a heterogeneous

environment showing a statistical significance. The financial services industry

represented only 2.7% of the test sample.

Dabos and Escudero (2004) explored the predictive properties of several financial

indicators regarding the failure of banking institutions in Argentina. Following the

devaluation of the Mexican peso in 1994, financial instability swept through the

economies of Central and South America. Dabos and Escudero examined public, private,

and mutual financial institutions in Argentina with a duration model. Using financial

ratios modeled after the indicators used by regulators in Argentina and the United States,

Dabos and Escudero found several indicators that were predictive of the ability of a
60

financial institutions to survive an external economic upheaval. The effectiveness of an

indicator differed by the class of institution (Dabos & Escudero, 2004).

Curry et al. (1999) studied the effect of enforcement actions by the FDIC on

distressed banks. The FDIC regulates and enforces the use of safe-and-sound

management practices at institutions they insure. Using onsite examinations and offsite

analysis of quarterly financial data, the FDIC attempts to detect unsafe and unsound

practices at the institutions they insure. Using several formal and informal enforcement

actions, the FDIC attempts to modify or change such practices.

Curry et al. (1999) examined enforcement actions to evaluate whether changes in

financial performance occurred. Curry et al. found that changes occurred in areas where

the management of the institution had control of the action. In areas where management

did not have control (i.e., raising outside capital), the enforcement actions did not assist

financial performance.

Wheelock and Wilson (2000) examined the factors that determine whether an

individual bank will fail or will be acquired. Wheelock and Wilson tested the hypothesis

that another bank will acquire a bank in financial distress because of management

deficiency rather than the bank’s failing. The premise in such decisions is that the

acquiring bank recognizes deficiencies and corrects them. Wheelock and Wilson built

upon previous studies and improved them by increasing the sample size, looking at

additional ways to evaluate management quality, and using a competing risk model to

evaluate the probability of acquiring and of failing. The model included the same

financial criteria used by regulators to determine management quality.


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The results of Wheelock and Wilson’s (2000) study confirmed many of the earlier

results that banks with poor capitalization are at greater risk of failure, and banks with

higher leverage and loan quality issues are at a higher risk of failure. Wheelock and

Wilson’s findings further confirmed that states permitting branch banking had a lower

risk of failure. The test of whether recognition of managerial inefficiencies would lead to

banks acquiring the deficient banks showed the opposite. Banks with managerial

deficiencies were more likely to fail. Wheelock and Wilson concluded the cost of

improving efficiency was too high for the acquiring bank.

Estrella et al. (2000) examined capital ratios as predictors in failing or declining

banking institutions. There have been many methodologies used in calculating the ratios

from complex risk-based calculations to simpler methods. Estrella et al. found that

capitalization of an organization had an inverse relationship to failure. The ratios used

were the level of capital as the numerator, and a factor used to represent the relative risk

that the capital is exposed as the denominator. Estrella et al. (2000) discovered that

simpler constructs of capital ratios were as predictive as the more complex constructs

over short time frames of 1 to 2 years. The more complex constructs were more

predictive over longer periods.

Not all researchers support financial performance analysis as a reliable indicator

of organizational decline. Financial indicator models are not without weaknesses.

Shunway (2001) used a hazard model to develop a predictive model for organizational

failure. The results of Shunway’s studies indicated that many financial ratios used in

static models were poor predictors within the Shunway’s model. Market size, stock

returns, and the standard deviation of stock returns were predictive of failure. When
62

combined with the two financial ratios of (a) net income to total assets and (b) total

liabilities to total assets, an accurate predictive model was developed (Shunway, 2001).

In a study of small businesses, Johnson and Rudesill (2001) found a rapidly

expanding small business had an increased risk factor of fraud, including management

fraud. In a study of certified public accountants specializing in small business audits,

Johnson and Rudesill concluded the lack of internal control systems in small businesses

was a contributing factor in the increased risk of fraud at small firms. The overall lack of

resources to staff and maintain sophisticated controls systems within small businesses

results from the inability to segregate duties as can be done in larger organizations. The

growth of a small business places a strain on its internal controls.

An OCC (1988) study found overly aggressive growth occurred before a bank’s

failure in 42% of the cases examined. Aggressive business behavior on the part of

management resulted in lack of compliance with lending procedures and an emphasis on

rapidly increasing loan growth. The OCC concluded that overly aggressive behavior by

management emphasizing rapid growth was a high-risk strategy that created

vulnerabilities within the bank and increased the risk of failure.

Rapid asset growth combined with falling capital ratios is an indicator of concern

for developing moral hazard within a banking institution (King et al., 2005). Reflecting

concerns of the consequences of high-risk strategies, the FDIC developed the Growth

Monitoring System [GMS]. The GMS used forward-looking indicators to identify

potentially high-risk growth strategies employed by banking institutions. Regulatory

agencies use growth rates and growth ratios as indicators of a bank requiring closer

examination.
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DeYoung (2003) studied newly chartered banks or de novo banks (i.e., in

operation 5 years or less) and the long-term probability of failure within this group.

Comparing de novo banks to small established banks in similar communities, the findings

indicated the failure rate for de novo banks was higher for systemic causes such as

business cycles. The failure rates were the same regarding improper business practices

and lax management. Rapid asset growth was associated with lax business practice and

excessive risk taking and was a long-term predictor of failure. DeYoung found failure to

grow at a sufficient rate to be a cause of failure in de novo banks but not in established

small banks.

Conclusion

There are many definitions for management fraud, but the definitions have in

common the fact that a person in a position of responsibility and authority abuses both

the responsibility and the authority (ACFE, 2004; Elliot & Willingham, 1980; O’Gara,

2004). Banking institutions have expanded stakeholder interests because of regulatory

administered depository insurance. The consequences of the act of management fraud

extend beyond the guilty individual to the organization and can cause far reaching

economic, political, and social implications (Ivancevich et al., 2003).

Criminology, psychology, sociology, organizational behavior, finance,

economics, ethics, accounting, and law are fields of study in which researchers have

studied the causes of management fraud (Zahra et al., 2005). While researchers have

attempted to explain management fraud (Cressey, 1971; Elliot & Willingham, 1980;

Jensen, 2004; Ludwig & Longenecker, 1993; Sutherland, 1973), each has built models
64

from the perspective of a single discipline. The factors that affect the occurrence of

management fraud are multidisciplinary and elusive.

The discovery of management fraud is common in the financial collapse of an

organization or the cause of the collapse (COSO, 1987; FDIC, 1997). Because of the

unique characteristics of the banking industry (Samolyk, 2004), the ability to identify

management fraud in the early stages affects regulators, individuals, and business. The

current study was an examination of methods of detecting the presence of management

fraud before the onset of repercussions.

Summary

Accurately defining or studying management fraud is not an easy task. Many

overlapping responsibilities and interactions between management, outside professionals,

regulators, and law enforcement exist in organizations. Literature on management fraud

belongs to academic research in accounting, ethics, criminology, and other disciplines.

Management fraud research is a convergence point for many different disciplines

(Cressey, 1971; Zahra et al., 2005).

Since the banking crisis of the 1980s, the community banking industry has shrunk

because of failure and unassisted mergers and acquisitions (Jones & Critchfield, 2004). A

frequently mentioned factor for failed banks is the presence of improper or fraudulent

behavior by insiders (OCC, 1988). The community banking segment of the banking

industry represents 94% of all banking companies within the United States (Critchfield et

al., 2004). Organizational decline is a major concern within the community banking

industry (OCC). Poor financial performance is representative of organizational decline

(Curry et al., 1999; Dabos & Escudero, 2004; Estrella et al., 2000).
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Researchers conducted extensive research to determine the characteristics and

predictability of organizations in or entering financial distress, also known as

organizational decline (Altman, 1983). Findings from several studies conducted after

large organizational failures indicated higher than anticipated involvement of senior

management in covering up or causing the causes of organizational decline and failure

(COSO, 1987). While studies have indicated that the risk of unethical and possibly

fraudulent behavior increased in organizational decline (Lemke & Schminke, 1991), not

all frauds by management result in financial failure nor are all organizations in decline

subject to fraud or unethical behavior. The current exploration of factors of

organizational decline in community banks with financial ratios as they relate to the

occurrence of management fraud contributed to existing research on the subject.

Chapter 3 begins with a detailed discussion of the research design, followed by a

description of types of financial ratios and the rationalization for their use. The chapter

includes the model for the study and the statistical tests used. Chapter 3 concludes with a

discussion of issues of validity and reliability.


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CHAPTER 3: RESEARCH METHODS

The purpose of the quantitative correlation study was to examine the relationship

between the occurrence of management fraud in community banks in the United States

and financial ratios the FDIC use to monitor the banks’ safety and soundness. The

research question for the study and the purpose and significance of the research were

topics in Chapter 1. Chapter 2 was a detailed review of literature within categories of (a)

historical perspectives of management fraud, (b) organizational decline, and (c) the

banking industry.

Chapter 3 begins with the rationale for the choice of research design and its

appropriateness. In research, the design flows from the research problem, the purpose of

the study, and the conceptual framework underpinning the study (Creswell, 2003). In the

current study, the research topic was management fraud, and its significance derived from

the research problem, the purpose statement, and the conceptual framework. Fraud by

managers and leaders is associated with economic failures that cause the loss of billions

of dollars each year and the economic dislocations of thousands of workers (Graham et

al., 2002).

Research Design

An approach to research can be qualitative, quantitative, or mixed with qualitative

and quantitative components. The basis for choosing a research approach should be

matching the research approach to the research problem (Karami, Rowley, & Analoui,

2006). The quantitative approach to the current study was appropriate because the

research problem involved identifying predictive methods to detect management fraud.


67

The qualitative approach is useful to study a central question or phenomenon in

an effort to explain the phenomenon. The quantitative research approach is appropriate

when the intent is “a description of trends or an explanation of the relationship among

variables” (Creswell, 2003, p. 50). The purpose of the quantitative correlational study

was to examine the relationship between the occurrence of management fraud in

community banks in the United States and financial ratios the FDIC uses to monitor the

safety and soundness of banks.

Many different designs are available to researchers (Creswell, 2003). In the

typical experimental research design, the experiment consists of manipulating conditions

for an experimental group and comparing scores with the scores of a control group. In the

study of unethical behavior such as management fraud, the manipulation of the

experimental group to perform illegal or unethical acts would itself be unethical (Lemke

& Schminke, 1991). In such cases, a correlation research design is appropriate.

A correlation study involves the examination of one or more characteristics of a

group to determine the degree of similarity or difference. The control and experimental

groups are determined with historical data. A researcher can examine the variables, as

they are, not subject to imposed behaviors. Correlational measures show the association

or lack of association between variables and do not indicate a causal relationship between

variables (Creswell, 2003).

In a correlation study, when the problem requires identifying the association or

lack of association between a dependent variable and two or more independent variables,

a regression analysis is appropriate (Creswell, 2003). When the dependent variable in the

correlation study is nonmetric (i.e., categorical), a multiple discriminate analysis or


68

logistic regression is an appropriate method of correlation analysis (Hair et al., 2006). A

logistic regression analysis is appropriate when questions exist concerning the underlying

assumptions such as the normality of distribution.

Logistic regression analysis is limited to the number of nonmetric dependent

variables. When two or more dependent variables exist within a study, multiple

discriminate analysis is more appropriate (Hair et al., 2006). Logistic regression models

are applicable when the single dependent variable is categorical (i.e., nonmetric) and the

independent variables are either metric or nonmetric (Hair et al., 2006). Logistic

regression predicts or explains a binary nonmetric dependent variable by determining the

likelihood of the independent variables influencing the dependent variable (Hair et al.,

2006). Logistic regression analysis was most appropriate for the current study.

The study involved examining the ability of financial ratios used by the FDIC to

predict the dependent variable, occurrence of management fraud. The dependent

nonmetric variable was the occurrence of management fraud, and the metric independent

variables were performance, growth, and capital ratios used by the FDIC. Data analysis

including testing the independent variables’ ability to predict the occurrence of

management fraud at intervals of 1, 2, and 3 years before the occurrence of management

fraud. The independent variables included 26 financial ratios expressing performance,

growth, and capital characteristics of community banks. Control variables denoting size,

location of the community bank, and time were used in the matched pairs design.

Figure 2 represents an outline of the analytic model of management fraud in

community banks used in the current research. In the model, the financial ratios of

performance, growth, and capital depict the data found in financial statements used to
69

determine the comparative condition of the community banks. Financial statements are a

documentation of management’s actions and numerical interpretations of the financial

condition of the bank.

Management fraud involves the overstatement, understatement, or misstatement

of a financial statement (O’Gara, 2004). Financial statements are a lens providing

transparency into the operations of community banks and management’s behavior. The

financial statements from banks contain financial ratios of performance, growth, and

capital, representing three of many possible perspectives in reviewing banks’ financial

statements. The focus of data analysis in the study was testing the ability of financial

ratios to provide an indication of the likelihood of management fraud.

Figure 2. The analytic model of management fraud in community banks.

While earlier researchers have suggested the existence of a relationship between

bank failure and management fraud (FDIC, 1997; OCC, 1988), they have produced
70

conflicting conclusions regarding the ability to predict the onset and mitigate the

consequences of management fraud (Kaminski et al., 2004). The definition of

management fraud in the study was a FDIC enforcement decision or order, specifically a

termination or prohibition order against an individual employed by the bank, declaring

the individual to have engaged in personal dishonesty against the bank (FDIC, 2005b).

The analysis involved testing three groups of financial ratios for the level of

correlation at time intervals of 1 year, 2 years, and 3 years before the year of discovery of

the management fraud incident. The performance ratios used as independent variables are

listed in Table 5. The FDIC calculates and publishes the performance ratios found in

Table 5 as part of the Call Report data. The table consists of all performance ratios

consistently published from 1992 to 2006.

Table 5

Performance Ratio Variables

Variable Name

ASTEMPM Assets per employee

EEFFR Efficiency ratio

ELNANTR Credit loss provision to net charge-offs

IDDIVNIR Cash dividends to net income

IDLNCORR Net loans and leases to core deposits

INATRESSR Loss allowance to loans

INLSDEPR Net loans and leases to deposits

INRESNCR Loan loss allowance to noncurrent loans

INTEXPY Cost of funding assets


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Table 5 (Continued)

INTINCY Yield on earning assets

NCLNLSR Noncurrent loans to loans

NIMY Net interest margin

NOIJY Net operating income to assets

NONIIY Noninterest income to earning assets

NONIXY Noninterest expense to earning assets

NPERFV Noncurrent assets plus OREO to assets

NTLNLSR Net charge-offs to loans

ROA Return on assets

ROE Return on equity

ROEEINJR Retained earnings to average equity

Table 6 lists the growth ratios used in the study. The growth ratios listed in Table

6 are part of the Growth Monitoring System [GMS] used by the FDIC and are all derived

from the Call Report data (King et al., 2005). The growth ratios are calculated using data

consistently gathered by the FDIC during the period 1992 to 2006.

Table 6

Growth Ratio Variables

Variable Name

ASTEMPM Assets per employee

EQV Equity capital to assets

ROLLPS5TA Growth ratio 1

ROVLTA Growth ratio 2


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Table 7 lists the capital ratios used as independent variables in the current study.

The FDIC calculated and published the capital ratios found in Table 7 as part of the Call

Report data. The table consists of all capital ratios consistently published from 1992 to

2006.

Table 7

Capital Ratio Variables

Variable Name

EQV Equity capital to assets

RBC1AAJ Core capital (leverage) ratio

RBC1RWAJ Tier 1 risk-based capital ratio

RBCRWAJ Total risk-based capital ratio

Gupta and Lalatendu (1999) and the BCBS (2004) have shown that

microeconomic and macroeconomic conditions contributed to bank failures. Matching is

a method used to control factors that might influence the outcome of the study (Creswell,

2003). The variables used in the present study to control macroeconomic and

microeconomic activities are listed in Table 8. The control of extraneous factors occurred

through matching a community bank where an occurrence of management fraud was

recorded with a community bank where no occurrence of management fraud was

recorded, based on the same relative size, in the same local economic conditions, and at

the same time interval.


73

Table 8

Control Variables

Variable Name

ASSET5 Average assets

LOC Location

YEAR Year of occurrence of management fraud

From 1996 to 2003, the FDIC issued 295 enforcement orders prohibiting

individuals from working at banking institutions (FDIC, 2007b). Not all enforcement

orders terminating employees include mention of personal dishonesty. A review of

enforcement orders terminating employees in 2003 indicated all 37 enforcement orders

mentioned personal dishonesty (FDIC, 2007b).

Enforcement orders generated the occurrences of management fraud examined in

the current study. The matching banks came from FDIC regulated banks with no

occurrence of management fraud. A fraud bank was matched to a no fraud bank by

matching asset size, location, and time interval. The total sample size of the study was

266 community banks.

Research Design Appropriateness

A quantitative research approach is appropriate when the intent is “a description

of trends or an explanation of the relationship among variables” (Creswell, 2003, p. 50).

The purpose of the quantitative correlation study was to examine the relationship between

the occurrence of management fraud in community banks in the United States and the

financial ratios the FDIC uses to monitor the safety and soundness of banks. In earlier

research, the OCC (1988), USGAP (1994), and the FDIC (1997) have suggested a link
74

between the occurrence of management fraud and financial failure. The focus of the study

was the ability of financial ratios used by the FDIC to explain and describe the conditions

that predict management fraud, the dependent variable.

The independent variables comprised the three groups of financial ratios of (a)

performance, (b) growth, and (c) capital ratios used by the FDIC during the years 1996 to

2003 as determinants of a community bank’s financial condition. The variables of asset

size, location, and the time of occurrence of management fraud controlled extraneous

economic conditions identified in previous studies (Altman, 1983; BCBS, 2004; Cebula,

1999). The control of extraneous economic conditions influences both the occurrence of

management fraud and financial failure.

Logistic Regression Model

Logistic regression is a specialized and predictive model used in cases where the

dependent variable is categorical with only two categories. Examples of binary

categorical variables are female/male, live/dead, and win/lose in which the variable must

be one or the other (Hair et al., 2006). In logistic regression, continuous and categorical

independents variables can predict the dependent variable. Logistic regression involves

the percent of variance in the dependent variable explained by the independent variables

to rank the relative importance of independent variables. The purpose is to assess

interaction effects of the variables and understand the impact of covariate control

variables (Garson, 2006).

Logistic regression transforms the dependent variable into the natural log of the

odds of occurrence and applies maximum likelihood estimation (MLE). Logistic

regression calculates the likelihood of an event occurring. Unlike ordinary least squares
75

(OLS) regression, logistic regression does not involve calculating changes in the

dependent variable; it involves calculating changes in the log odds of the dependent

variable.

Like OLS regression, logistic regression uses coefficients in the regression model

but uses logit coefficients. The logit coefficients correspond to beta weights, and a

pseudo R2 statistic is available to summarize the strength of the relationship. Unlike OLS

regression, linearity between the independent variables and the dependent variable is not

assumed, normal distribution of the variables is not required, and homoscedasticity is not

assumed. In general, logistical regression has less stringent requirements. Logistical

regression requires independent observations and linearity between the independent

variables related to the logit of the dependent variable (Garson, 2006).

Many similarities exist in the application and interpretation of multivariate

techniques such as analysis of variance (ANOVA) and logistical regression. The key

difference is that, in logistical regression, the dependent variable is categorical, not metric

(Hair et al., 2006). ANOVA requires the dependent variable to be continuous. Logistical

regression has the advantage of being less affected by a lack of normality in the

dependent variables (Hair et al., 2006).

Research Questions

The purpose of the quantitative correlation study was to examine the relationship

between the occurrence of management fraud in community banks in the United States

and financial ratios the FDIC uses to monitor the safety and soundness of banks. In

quantitative studies, research questions narrow the purpose of the study (Creswell, 2003).

Research questions synthesize the purpose of the study in order to focus and craft the
76

relationship to be studied (Cone & Foster, 2003). The research question guiding this

study was, “How does the financial condition of a community bank, as measured by

financial ratios used by the FDIC, relate to the occurrence of management fraud in the

bank?”

Performance ratios are one type of financial ratio used to measure the relative

performance of an organization within an industry. Performance ratios are an indicator of

the relative financial condition of an organization and have been used successfully in

models of organizational failure and decline in banks (Dabos & Escudero, 2004). The

FDIC used the 20 different performance ratios listed in Table 1 as indicators of the

financial condition of a community bank. The ratios were the independent variables of

the study.

Growth ratios are another type of financial ratio the FDIC and other regulators

used to monitor the safety and soundness of banks (King et al., 2005). Four different

growth ratios used by the FDIC as indicators of the financial condition of a community

bank became independent variables in the study. The four growth ratios were (a) assets

per employee, (b) equity capital to assets, (c) loans and leases plus long-term securities to

assets, and (d) volatile liabilities to assets.

Capital ratios are a class of financial ratios used in predicting credit worthiness

(Altman, 1983). Estrella et al. (2000) found capital ratios to be predictors of bank failure.

Regulators use different types of capital ratios to manage the risk-taking behavior of bank

leaders. Capital ratios have shown a propensity to predict failure at differing time

intervals. Four different capital ratios used by the FDIC as indicators of the financial

condition of a community bank became independent variables in the study. The capital
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ratios were (a) equity capital to assets, (b) core capital (leverage) ratio, (c) tier 1 risk-

based capital ratio, and (d) total risk-based capital ratio.

Hypotheses

Hypotheses, framed by the research question, facilitate a specific form of inquiry

(Creswell, 2003). The study hypotheses identified financial ratios used by the FDIC as

indicators of the financial condition of a community bank. Three categories of financial

ratios (i.e., performance ratios, growth ratios, and capital ratios) were used as sets of

independent variables in the study. The three categories of financial ratios produced null

hypotheses and corresponding alternative hypotheses.

The first hypothesis pertains to performance ratios.

H10: Community banks with poor performance ratios do not incur an increased

occurrence of management fraud.

H11: Community banks with poor performance ratios have an increased occurrence of

management fraud in subsequent years.

The second hypothesis pertains to growth ratios.

H20: Community banks with high growth ratios do not incur an increased occurrence

of management fraud.

H21: Community banks with high growth ratios have an increased occurrence of

management fraud in subsequent years.

The third hypothesis pertains to capital ratios.

H30: Community banks with low capital ratios do not incur an increased occurrence

of management fraud.
78

H31: Community banks with poor capital ratios have an increased occurrence of

management fraud in subsequent years.

The information used in the study was public data collected by the FDIC in the

course of its regulatory duties and published on the FDIC Web site. Determination of

fraudulent activity was a termination/prohibition order against an individual employed by

the bank declaring the individual to have engaged in personal dishonesty against the bank

(FDIC, 2005b).

Population

The target population for the research was community banks in the United States.

The definition of a community bank was any bank monitored by the FDIC with assets

below $1 billion. The primary source of data was the FDIC as regulator of the banking

industry. The banking industry has four federal regulators that are the FDIC, the FRS, the

OCC, and the OTS. Each regulator has a supervisory responsibility for specific classes of

banking institutions. In the case of community banks in the United States, the primary

regulator is the FDIC. During the period 1996 to 2006, there were between 4,959 and

6,202 community banks whose primary regulator was the FDIC (FDIC, 2007a).

The FDIC provides depository insurance for member institutions to support

confidence in the banking system of the United States. As part of its charter, the FDIC

monitors its members for risks affecting their insurability and the impact of a failure on

the banking system (FDIC, 2005c). As part of the FDIC duties to monitor the safety and

soundness of insured banks, the agency collects financial and demographic data on a

quarterly basis. Over time, the FDIC has modified the data elements collected to reflect

the changing banking environment. The study data came from the financial and
79

demographic elements in the matched pairs design to develop a sample of 266

community banks.

Sampling Frame

A matched pairs design facilitated the selection of the experimental or

management fraud group and of the control group consisting of no fraud banks. The

matched pairs design produced measurements of the value of the dependent variable,

which was the occurrence of management fraud, by controlling for extraneous facts that

can influence the independent variables. Altman (1983), BCBS (2004), and Cebula

(1999) found that macroeconomic and microeconomic conditions were extraneous factors

affecting management fraud and financial decline. Previous researchers used the matched

pairs design successfully to study the occurrence of management fraud (Beasley et al.,

2000; Crutchley et al., 2007; Saksena, 2001; Williams et al., 2000) and organizational

decline (D’Aveni, 1989).

Under the definition of community bank used in the study, the number of

community banks in the United States has varied from 10,906 in 1996 to 8,064 in 2006

(FDIC, 2007a). The number of community banks with the FDIC as the primary

regulatory agency was 56% to 61% of all community banks during the same period. This

subset of community banks generated the sample for the study. Termination or

prohibition orders issued by the FDIC as primary regulator formed the basis for selecting

FDIC-insured community banks where management fraud has occurred. The

experimental group was matched with community banks of the same asset size, from the

same geographic location, and in the same time interval with the FDIC as the primary

regulator that did not have a termination or prohibition order issued by the FDIC
80

To ensure the matching community banks did not have an unreported occurrence

of management fraud, records of the matching bank were searched for any termination or

prohibition orders issued against the bank’s employees for 3 years subsequent to the

matching date. The performance, growth, and capital ratios for matched community

banks were drawn from the same time intervals based upon the year of occurrence of

management fraud of the experimental group of community banks. The data drawn from

the FDIC were matched and sorted using MS Excel software.

To insure an adequate sample size, a minimum of five observations for each

independent variable is recommended (Hair et al., 2006). In the study, 26 independent

variables requiring a minimum of 130 observations supported the achievement of

statistical significance with the logistical regression analysis. From 1996 to 2003, the

FDIC issued 295 enforcement orders prohibiting individuals from working at banking

institutions (FDIC, 2007a).

The FDIC enforcement orders facilitated the identification of the community

banks where there has been an occurrence of management fraud. While not all

enforcement orders prohibiting or terminating persons include mention of personal

dishonesty, a review of enforcement orders prohibiting or terminating persons in 2003

indicated that all 37 enforcement orders mentioned personal dishonesty (FDIC, 2007b).

All qualifying community banks with fraud occurrence matched with an equal number of

no fraud banks became participants in the study for a total sample size of 266 community

banks.
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Geographic Location

The purpose of the quantitative correlation study was to examine the relationship

between the occurrence of management fraud in community banks in the United States

and financial ratios the FDIC uses to monitor the safety and soundness of banks.

Between1996 and 2003, the FDIC (2007b) issued 295 termination or prohibition orders.

Not all the termination or prohibition orders were for officers or employees of

community banks and not all included an incident of personal dishonesty as required by

the study definition of management fraud. To ensure a large enough sample was available

for the study, the geographic location was the United States. To ensure the control of

regional differences in economic operating conditions, the geographic location within the

United States was a control variable in the matched pairs design of the study.

Informed Consent and Confidentiality

There was no requirement to obtain informed consent from community bank

because the information needed was in the public domain. The data for the study were

obtained through the FDIC Web site. The FDIC provides an extensive publicly available

database of bank financial performance. The publicly available information includes the

name, addresses, holding company affiliation, and extensive financial information of all

banks insured by the FDIC.

The FDIC accumulates these data from a standardized report, referred to as a Call

Report. All member banks file the Call Report quarterly. The termination or prohibition

orders used to define the occurrence of management fraud also came from public

information found in the FDIC Web site (FDIC, 2007b).


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The raw data available from a public domain were reorganized, coded, and

analyzed to test the hypotheses. During and after the data organization and analysis

process, the coded data were stored in a locked cabinet and were accessible only by the

researcher. All data will be secured for a period of 3 years after completion of the

dissertation and destroyed by shredding after that time.

Data Collection

Evidence from the data collected provided answers to the research question and

hypotheses of the study. According to Creswell (2003), the manner of data collection

influences the ability to draw conclusions. The ability to analyze data and to generalize

findings is a function of the methods and procedures used in collecting the data.

According to Benston (2004), banks are interesting environments for research.

Banks have common products in loans, deposits, checking accounts, and they have

readily collectable data provided by regulators such as the FDIC. The data are

standardized, available over a long time horizon, and comparable.

In the banking industry, the need to provide accurate, timely, and meaningful data

to depositors is balanced with issues of privacy, individual rights, and regulatory

requirements. Federal regulators discourage banks from disclosing certain information

concerning regulator examinations, informal enforcement actions, and the specific

methodologies regulators use (Curry et al., 1999). Current or ongoing investigations

concerning regulatory or law enforcement agencies are not disclosed. Qualitative

methods of data collection are compromised when research participants cannot be

forthcoming (Creswell, 2003). The use of historic data in the current quantitative
83

approach increased the validity of the results but did not eliminate the possibility of an

unreported occurrence of management fraud.

A primary source of data on the banking industry is the FDIC. The FDIC

possesses the authority to take several types of enforcement actions against member

banks and their officers and directors. The FDIC can take formal and informal

enforcement actions against the institutions the agency supervises. Informal actions are

board resolutions and memoranda of understanding to effect changes in the operations

and management of the institution. In situations that are more serious or where informal

actions are ineffective, the FDIC takes formal enforcement actions including written

agreements, cease and desist orders, termination or prohibition orders against individuals,

the removal of officers and directors of the institution, and monetary penalties (FDIC,

2005c).

The purpose of enforcement actions is to bring about changes in the behaviors

that are causing problems at an institution, to stop detrimental actions, and to prevent

losses to the deposit insurance fund. Some of the actions are informal and not disclosed

publicly. Other actions such as cease-and-desist orders, suspension or removal of

individuals, civil money penalties, suspension or termination of deposit insurance, or the

placement in receivership are formal and public actions (Curry et al., 1999).

In the current study, the formal FDIC enforcement action of a termination or

prohibition order against an individual employed by the bank, declaring the individual to

have engaged in personal dishonesty against the bank indicated an occurrence of

management fraud. The FDIC enforcement orders are available for download from the

FDIC Web site. A sample copy of a FDIC enforcement action of a termination or


84

prohibition order against an individual employed by the bank, declaring the individual to

have engaged in personal dishonesty against the bank, is provided in Appendix B. During

the processing phase of data collection, the raw data obtained from the public domain

were reorganized and coded in preparation for analysis to test the hypotheses.

Call Reports

The FDIC provides an extensive database of bank financial performance that is

publicly available. The FDIC accumulates these data from a standardized report, referred

to as a Call Report, filed quarterly by all member banks. The Call Report captures

detailed financial, performance, and demographic information at the individual bank

level. The reports are available to the public approximately 8 weeks after the end of the

quarter (FDIC, 2005a).

The independent variables of the study were the performance ratios and capital

ratios provided in the FDIC data and the FDIC data to calculate the growth ratios. The

financial ratio data provided by the FDIC represent metric data of the sample community

banks as appropriate for independent variables when using logistic regression analysis

(Hair et al., 2006). The control variables of asset size, location, and time interval were

data captured by the Call Reports published by the FDIC. The data for the period 1992 to

the present account for the preceding time intervals and post intervals and matched the

requirements of the current study. A sample of a community bank FDIC statistical

download is provided in Appendix C.

Year-end Call Report data are available to the public for the years 1992 to 2006

from the FDIC Web site. The FDIC data are in the form of Microsoft Office Excel

Comma Separated Values Files. FDIC enforcement actions are available from the FDIC
85

Web site with individual documents on each action available for downloading. The

documents include a copy of the actual enforcement order in html or pdf file format. All

enforcement actions were reviewed and entered into a MS Excel spreadsheet and were

sorted by category, type of action, and year. Individual documents on each action were

available for downloading.

The data for the matched-pairs of community banks were collected and sorted in

an MS Excel spreadsheet and entered into the analysis software. The logistic regression

analysis of the collected data was conducted using SPSS Graduate Pack 15.0 for

Windows®. Logistic regression analysis is suited for the dichotomous dependent variable

and metric independent variables (SPSS, 2006) used in the study.

Research Instruments

The research instruments used in the study consisted of the FDIC statistical Web

site, the FDIC enforcement orders, SPSS Graduate Pack 15.0 for Windows® software,

and the logistical regression model. The logistic regression model was modified to reflect

the time intervals observed. A logistical regression analysis was conducted using the

SPSS Graduate Pack 15.0 for Windows® software with the data from the three groups of

financial ratios, drawn from the FDIC statistical Web site at intervals of 1, 2, and 3 years,

and with the data regarding occurrence of management fraud drawn from the FDIC

enforcement orders. The intent was to measure the predictability of the independent

variables at different stages.

The Logistic Regression Model Formula

The logistic regression model formula computes the probability of the selected

response as a function of the values of the independent variables. In the study, the
86

independent variables were segmented into the three groups representing performance,

growth, and capital ratios. Logistic regression predicts or explains a binary nonmetric

variable (Hair et al., 2006). In the study, the dependent nonmetric variable was the

occurrence of management fraud, and the metric independent variables were

performance, growth, and capital ratios.

The logistic regression model was expressed as

P = 1/(1+exp(-(B0 + B1*X1 + B2*X2 + . . . + Bk*Xk)

where P is the probability of occurrence, B0 is a constant and Bi are coefficients of the

independent variables, and Xi are the independent variables (Statsoft, 2006).

Since the goal of the study was to provide guidance in predicting the occurrence

of management fraud before its occurrence at different intervals, the amended model was

P = 1/(1+exp(-(B0 + B1*X1(t-y) + B2*X2(t-y) + . . . + Bk*Xk(t-y))

where P is the probability of occurrence, B0 is a constant and Bi are coefficients of the

predictor variables, Xi are the independent variables, t is the year of occurrence, and y is

the interval in years.

Instrument Validity

The validation of a logistical regression model is accomplished by using two

sample sets, a holdout set and an analysis set (Hair et al., 2006). The study sample is

randomly divided into two sets. The analysis set is used to estimate the logistic regression

model and the holdout set is used to validate the estimation. Test of the validity and

significance of the logistical regression model occurs through examining the hit ratio,

which is the percentage of correct classification of the dependent variable by the model of
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the holdout set to the analysis set (Hair et al., 2006). In the study, the sample size of 266

produced a sample large enough to divide into the two sample sets required to test for

validity of the model.

Internal and External Validity

The study involved the use of historic data collected by the FDIC in the analysis

of financial ratios and management fraud. The consistency, standardization, and

regularity of the data maintained by the FDIC encourage stable reliability of the data

(Colorado State University, 2007). As primary regulatory for community banks, the

FDIC provides a consistent basis for the treatment of termination or prohibition orders,

the definition of management fraud in the study. The activities conducted to maximize

data validity are correlated to the reliability and validity standards such as objectivity,

reliability, internal validity, and external validity.

Objectivity

Because the data used in the study were drawn from existing sources such as the

FDIC, biases and prejudices from the originating source could have affected the study

findings. The results could be subject to participant biases and prejudices of the person

who updates the FDIC Web site daily, quarterly, and annually. It was assumed that the

FDIC employees collect and classify the data objectively. Neutrality was maintained in

the study when collecting, coding, and analyzing the FDIC data.

Reliability

Macroeconomic and microeconomic conditions have been shown to be

contributing factors to the financial condition of an organization (Altman, 1983; BCBS,

2004; Cebula, 1999). By matching the experimental banks with banks of the same size, in
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the same location, and in the same period, both sets of community banks were subject to

the same economic conditions. Accounting for extraneous factors increases the reliability

of the collected data (Creswell, 2003). The data collected by the FDIC are subject to

Generally Accepted Accounting Principles (GAAP) and federal reporting regulations,

increasing standardization and reliability of the data. An assumption of the study was that

the data collected were reliable.

Internal Validity

Standardization of the data collected in the Call Reports strengthened the internal

validity of the findings. Previous researchers (e.g., Cebula, 1999; Collier et al., 2003;

Curry et al., 1999, 2001; DeFerrari & Palmer, 2001) have used FDIC data effectively.

Differing applications of enforcement actions over time could have threatened internal

validity. The large size of the matched pairs sample with the same time intervals lessened

such possibility.

External Validity

External validity is the ability to generalize the findings to other settings

(Creswell, 2003). Community banks are less complex institutions than larger banks

(DeFerrari & Palmer, 2001), precluding the generalization of the findings about small

banks to larger banks. The highly regulated nature of the banking industry makes

generalizations outside the banking industry difficult. Changes in regulatory mandates,

operating rules, and reporting requirements imposed by the FDIC can affect the

community bank industry.


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Data Analysis

The logistic regression analysis of the collected data was conducted using SPSS

Graduate Pack 15.0 for Windows®. Logistic regression analysis has been used

successfully in studies of management fraud in organizations other than banks (Saksena,

2001). Logistic regression analysis is suited for the dichotomous dependent variable and

metric independent variables (SPSS, 2006) of the study. The logistical regression formula

instrument was run on each hypothesis expression, H1, H2, and H3, of the logistical

regression model. The model analyzed data from intervals of 1, 2, and 3 years from the

occurrence of management fraud on all three hypothesis expressions of the logistical

model.

The analysis tested the financial ratios for the level of correlation at time intervals

of 1 year, 2 years, and 3 years preceding the year of discovery of the management fraud

incident. The logistic regression analyzed the data for each participating community bank

three times, 1 year before the occurrence of management fraud, 2 years before the

occurrence of management fraud, and 3 years before the occurrence of management

fraud. The financial ratios variables as shown in Tables 5 and 7 were the performance and

capital ratios calculated and published by the FDIC as part of the Call Report data. The

growth ratios as shown in Table 6 were part of the Growth Monitoring System [GMS]

used by the FDIC (King et al., 2005).

Performance Ratios

Hypothesis H10 involved performance ratios.

H10: Community banks with poor performance ratios do not incur an increased

occurrence of management fraud.


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To test Hypothesis H10, the logistic regression model formula was applied to the

hypothesis. H10 tested the effects of performance ratios in predicting the occurrence of

management fraud. The performance ratios were from quarterly reports by the FDIC

(FDIC, 2005a). The performance ratios were from year-end intervals. Using the logistical

regression formula instrument and substituting the performance ratio variables listed in

Table 4 as X1(t-y) . . . Xk(t-y), H10 expressed itself in the logistic regression model as

P(H10) = 1/(1+exp(-(B0+ B1 *(ASTEMPM)(t-y) + B2*(EEFFR)(t-y) +

B3*(ELNANTR)(t-y) + B4*(IDDIVNIR)(t-y) + B5*(IDLNCORR)(t-y) + B6*(INATRESR)(t-y) +

B7*(INLSDEPR)(t-y) + B8*(INRESNCR)(t-y) + B9*(INTEXPY)(t-y) + B10*(INTINCY)(t-y) +

B11*(NCLNLSR)(t-y) + B12*(NIMY)(t-y) + B13*(NOIJY)(t-y) + B14*(NONIIY)(t-y) +

B15*(NONIXY)(t-y) + B16*(NPERFV)(t-y) + B17*(NTLNLSR)(t-y) + B18*(ROA)(t-y) +

B19*(ROE)(t-y) + B20*(ROEEINJR)(t-y))

where P is the probability of occurrence, B0 is a constant and Bi are coefficients of the

predictor variables, Xi are the performance ratio independent variables, t is the year of

occurrence, and y is the interval in years.

Growth Ratios

Hypothesis H20 involved growth ratios.

H20: Community banks with high growth ratios do not incur an increased occurrence

of management fraud.

To test Hypothesis H20, the logistic regression model formula was applied to the

hypothesis. H20 tested the effects of the growth ratios in predicting the occurrence of

management fraud. The FDIC uses growth ratios as part of a forward-looking model of

possible financial distress (King et al., 2005). The growth ratios were from year-end
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intervals. Using the logistical regression formula instrument and substituting the growth

ratio variables listed in Table 5 as X1(t-y) . . . Xk(t-y), H20 expressed itself in the logistic

regression model as

P(H20) = 1/(1+exp(-(B0+ B1 *(ASTEMPM)(t-y) + B2*(EQV)(t-y) +

B3*(ROLLPS5TA)(t-y) + B4*(ROVLTA)(t-y)

where P is the probability of occurrence, B0 is a constant and Bi are coefficients of the

predictor variables, Xi are the growth ratio independent variables, t is the year of

occurrence, and y is the interval in years.

Capital Ratios

Hypothesis H30 involved capital ratios.

H30: Community Banks with low capital ratios do not incur an increased occurrence

of management fraud.

To test the Hypothesis H30, the logistic regression model formula was applied to

the hypothesis. H30 tested the effects of the capital ratios in predicting the occurrence of

management fraud. Capital ratios are one of the more effective tools used by regulators in

determining the risk of failure in banks (Estrella et al., 2000). Using the logistical

regression formula instrument and substituting the capital ratio variables listed in Table 6

as X1(t-y) . . . Xk(t-y), H30 expressed itself in the logistic regression model as

P(H30) = 1/(1+exp(-(B0+ B1 *(EQV)(t-y) + B2*(RBC1AAJ)(t-y) +

B3*(RBC1RWAJ)(t-y) + B4*(RBCRWAJ)(t-y)

where P is the probability of occurrence, B0 is a constant and Bi are coefficients of the

predictor variables, Xi are the capital ratio independent variables, t is the year of

occurrence, and y is the interval in years.


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Computational Issues for Logistic Regression

The use of logistic regression rather than OLS regression was based on the fact

that logistic regression does not have many of the restrictive assumptions of OLS

regression (Garson, 2006). In logistic regression, the relationship between dependent and

independent variables is not assumed linear. The distribution of the dependent variable

and the distribution of error terms need not be normal. The dependent variable is not

required to be homoscedastic, and there is no variance assumption of homogeneity.

In logistic regression, all relevant variables are assumed included in the model.

Failure to include all relevant variables would misallocate any common variance of other

variables or inflate the error term. Excluding all irrelevant variables is also assumed.

Inclusion of irrelevant variables in the model would cause any shared common variances

to be incorrectly attributed. The standard errors of the regression coefficients would

increase with the correlation of the irrelevant variables and the independent variables

(Garson, 2006).

In logistic regression, it is assumed that error terms are independent. Violating

this assumption has serious consequences. Violations occur when participants provide

observations at multiple points in time. Logistic regression assumes there are no missing

cases and a low measurement error (Garson, 2006).

While a linear relationship between the independent and dependent variables is

not required in logistical regression, a linear relationship is assumed between the

independent variable and the log odds of the dependent variable. The logistic regression

underestimates the degree of relationship between the independent and dependent


93

variable when the assumption of linearity is violated and generates Type II errors.

Interaction effects known as additivity are not accounted for in logistic regression. The

exception occurs when interaction terms are added as additional variables in the analysis

(Garson, 2006).

Logistical regression assumes that there is no multicollinearity between

independent variables. When an independent variable is a linear function of another

independent variable, multicollinearity occurs. The standard errors of the coefficients

increase. Multicollinearity does not change the estimates of the coefficients as the

correlation between independent variables increase, decreasing reliability.

Multicollinearity is signaled by high standard errors. Logistical regression assumes there

are no outliers (Garson, 2006).

In logistic regression analysis, the coefficients of the independent variables are

estimated using an iterate algorithm. Instead of minimizing the squared deviations as in

linear regression, logistician regression seeks to maximize the likelihood of an event

occurring (Hair et al., 2006). In logistical regression, reliability of the maximum

likelihood estimate (MLE) decreases as the sample size decreases. Conversely, the

reliability of the MLE increases as the sample size increases. The convergence process of

the MLE is dependent on an adequate sample size. Hair et al. (2006) recommended there

be at least five events for each parameter in the logistic regression model. The adequacy

of the sample can affect the goodness of fit measures.

Statistical significance is more difficult to show in small samples. In logistic

regression, it is assumed that the expected dispersion of the variance of the dependent

variable and the actual dispersion are small. Large discrepancies between the expected
94

variance of the dependent variable and the observed variance signify problems with the

randomness of the sample. The sample size of the study, 266 events, exceeded the

recommended minimum requirements of five events per parameter.

Summary

The purpose of the study was to examine the relationship between the occurrence

of management fraud in community banks in the United States and financial ratios the

FDIC uses to monitor the safety and soundness of banks. The dependent nonmetric

variable was the occurrence of management fraud, and the metric independent variables

were performance, growth, and capital ratios used by the FDIC (2005a). The study tested

the independent variables ability to predict the occurrence of management fraud at

intervals of 1, 2, and 3 years before the occurrence of management fraud. In total, 26

financial ratios expressing performance, growth, and capital characteristics of community

banks (FDIC, 2005a) were the independent variables. The variables denoting size,

location of the community bank, and time controlled extraneous variables in the matched

pairs design (Altman, 1983; BCBS, 2004; Cebula, 1999).

The model for the study was financial statements as numerical interpretations of

the financial condition of the bank (Altman, 1983). The financial statements from banks

contain the financial ratios of performance, growth, and capital. The financial ratios are

three of many potential perspectives when reviewing the financial statements from banks.

The FDIC provides an extensive database of bank financial statements as well as

prohibition and termination orders against bank officers and directors, and the

information is available to the public (FDIC, 2007a). Logistic regression was used in the

analysis of the collected data, using SPSS Graduate Pack 15.0 for Windows®. The
95

logistical regression formula instrument was run on each hypothesis expression, H1, H2,

and H3, of the logistical regression model.

Chapter 4 is a report of the results of the logistical regression analysis. The

discussion of the findings includes the validity and reliability of the model and instrument

and the generalizations applicable to the general population of community banks and the

larger audience of the banking industry.


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CHAPTER 4: RESULTS

The purpose of the quantitative correlational study was to examine the

relationship between the occurrence of management fraud in community banks in the

United States and financial ratios the FDIC uses to monitor the banks’ safety and

soundness. Earlier studies by the OCC (1988), USGAO (1994), and the FDIC (1997)

indicated a possible link between the occurrence of management fraud and financial

failure. The current study was an examination of the ability of financial ratios used by the

FDIC to measure financial soundness in order to predict the occurrence of management

fraud.

A total of 133 matched pairs of community banks of similar size and location was

the sample for the study. Banks where management fraud occurred were matched with

banks where no management fraud was discovered. The definition of management fraud

in the study was a termination or prohibition order by the FDIC, specifically against an

individual employed by the bank.

The logistical regression model instrument was applied to three sets of financial

ratios (i.e., performance, growth, and capital) for the sample group of community banks

at three time intervals. The three sets of financial ratios are shown in Tables 5, 6, and 7.

The time intervals were 1, 2, and 3 years before the initiation of the termination or

prohibition order. The 26 dependent variables, and the three time-interval iterations

generated a large and complex number of statistics. The analysis of the logistic regression

model instrument begins with a review of the data collection procedures, a discussion of

the logistic regression instrument model by hypotheses and time interval iteration, and a
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discussion of significant dependent variables within the logistic regression instrument

model.

Review of Data Collection Procedures

The selection of the experimental or management fraud group and the control

group occurred through the use of a matched pairs design. The matched pairs design

permits the measurement of the value of the dependent variable (i.e., occurrence of

management fraud) by controlling for extraneous facts that might influence the

independent variables (i.e. the three sets of financial ratios). Earlier researchers used the

matched pairs design successfully to study the occurrence of management fraud (Beasley

et al., 2000; Crutchley et al., 2007; Saksena, 2001; Williams et al., 2000) and

organizational decline (D’Aveni, 1989).

FDIC financial data generated the sample of community banks. Termination or

prohibition orders issued by the FDIC as primary regulatory agency formed the basis for

the selection of community banks where management fraud occurred. The experimental

group was matched with community banks in the same time interval, from the same

geographic location, and of similar asset size where the FDIC was the primary regulator

but did not issue a termination or prohibition order.

The community banks where management fraud had occurred were first matched

for location by state and county. The no fraud community banks were selected as the

community banks closest in asset size within the same county with the FDIC as primary

regulator. If no matching community bank was found in the same county, the search was

extended to all contiguous counties within the state.


98

To ensure the matching community banks did not have an unreported occurrence

of management fraud, 3 years of data subsequent to the matching date for any termination

or prohibition orders issued against the matching bank employees were examined. The

performance, growth, and capital ratios for matched community banks were from the

same time intervals based upon the year of occurrence of management fraud. The year of

occurrence of management fraud was determined from the docket number assigned by

the FDIC. The FDIC assigns a unique reference to every action it takes against member

banks. The first two digits of the reference indicate the year the action was initiated

(FDIC, 2007b).

The total sample size was 266 community banks forming 133 matched pairs of

community banks. The sample exceeded the recommended minimum sample size of five

observations for each independent variable or 130 (Hair et al., 2006). All data were from

year-end intervals. The data drawn from the FDIC were matched and sorted using MS

Excel software. The logistic regression analysis of the collected data was conducted using

SPSS Graduate Pack 15.0 for Windows®.

Performance, growth, and capital ratios were the independent variables. The

FDIC used these three groups of ratios during the years 1996 to 2003 as determinants of a

community bank’s financial condition. The three groups of financial ratios were

examined for their ability to predict the dependent variable, occurrence of management

fraud. The control variables were asset size, location, and the time of the occurrence of

management fraud. The control variables were used to control any extraneous economic

conditions (Altman, 1983; BCBS, 2004; Cebula, 1999).


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Descriptive Statistics

Descriptive statistical tests were conducted between the fraud and no fraud groups

of community banks within the sample to determine differences between the two groups.

Means, standard deviations, the standard error means, and the number of observations

were determined and histograms drawn. The t tests were performed comparing the

differences between the independent variables of the fraud and no fraud community

banks. The t tests were performed for each group of financial ratios, performance,

growth, and capital, at the three time intervals.

The results of the descriptive statistics are included in appendices. Appendix D

includes the means, standard deviations, standard error means, and the number of

observations for all performance, growth, and capital ratios models at all three time

intervals. Appendix E includes the t tests of the performance, growth, and capital models

at all three intervals. Appendix F includes the histograms of all 26 financial ratio

independent variables separated into fraud and no fraud groups for all three time

intervals.

Analysis of the means, standard deviation, standard error means, and histograms

indicated similar distribution patterns in the fraud and no fraud groups among the

independent variables. The t tests assumed both equal variance and not equal variance.

There was no difference in the significance levels of the independent variable in either

assumption. To avoid confusion in presenting the data of the t test for independence,

equal variance was assumed.

The number of significant variables in each hypothesis is listed in Table 9. The t

test for independence showed a larger percentage of variables in the performance ratio
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model H1 were significant as the time interval was closer to the occurrence of

management fraud. One variable in the performance ratio model, ELNANTR credit loss

provision to net charge-offs, were not significant in all time intervals. The growth ratio

model showed a narrow rise and fall because of the lower number of variables in the

model. The capital ratio model showed a consistent pattern of all variables being

significant in all three-time intervals.

Table 9

Number of Significant Variables by Hypothesis

Number of significant

variables

Hypothesis Number of t-1 t-2 t-3

Variables

Performance Ratio Model H1 20 16 18 9

Growth Ratio Model H2 4 2 4 3

Capital Ratio Model H3 4 4 4 4

An analysis of any missing data was conducted. The reported missing data were a

result of the use of ratios as the dependent variable. In all cases of missing data, the

denominator of the ratio was zero. This ratio represents a value that cannot be calculated

rather than an absence of data, producing a result noted as N/A (i.e., not applicable) in the

FDIC data and is represented as a blank cell in the FDIC data download (FDIC, 2007a).

The two performance ratios in the performance ratio model, ELNANTR and

LNRESNCR, showed 14 cases and 17 cases of missing data, respectively. The

performance ratios ELNANTR credit loss provision to net charge-offs, and LNRESNCR
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loan loss allowance to noncurrent loans, represented 79.5% of all missing data. The

logistic regression analysis software eliminated cases where data were missing from the

analysis.

In the performance ratio model H1, 91% to 89.5% of all cases were included in

the logistic regression analysis. The growth ratio model H2 showed only a few instances

of missing data with no ratio having more than two cases of missing data. In the growth

ratio model H2, 99.6% of all cases were included in the logistical regression analysis.

The capital ratio model H3 had no missing data, and 100% of all data were included in

the logistic regression analysis.

Performance Ratio Model H1

Descriptive statistics for the performance ratio model H1 consisted of the means,

standard deviation, standard error means, and number of observations (see Appendix D).

All t test results for the performance ratio model H1 are included in Appendix E. The t

test performed on the performance ratio model H1t-1 showed four ratios out of 20 that

were not significant. The performance ratios that did not have significance between the

fraud and no fraud groups were NIMY net interest margin, fraud (M = 4.53, SD = 1.09),

no fraud (M = 4.37, SD = 1.03), t(264) = -1.20, p = .23 (two-tailed); ELNANTR credit loss

provision to net charge-offs, fraud (M = 152.65, SD = 620.06), no fraud (M = 101.61, SD

= 2775.83), t(250) = -.20, p = .84 (two-tailed), IDDIVNIR cash dividends to net income,

fraud (M = 30.97, SD = 86.16), no fraud (M = 38.50, SD = 58.04), t(263) = .84, p = .40

(two-tailed), and LNLSDEPR net loans and leases to deposits, fraud (M = 71.60, SD =

15.41), no fraud (M = 68.25, SD = 19.83), t(264) = -1.54, p = .12 (two-tailed). The

remaining 16 ratios all showed significance.


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The t tests performed on the performance ratio model H1t-2 showed two

performance ratios that were not significant when the fraud and no fraud groups were

compared. The two variables showing no significance were NIMY net interest margin,

fraud (M = 4.67, SD = 1.23), no fraud (M = 4.44, SD = 1.00), t(264) = -1.62, p = 1.07

(two-tailed) and ELNANTR credit loss provision to net charge-off, fraud (M = 113.50, SD

= 586.59), no fraud (M = 183.93, SD = 1230.51), t(251) = .58, p = .56. Both independent

variables were shown to be not significant in H1t-1. The other 18 performance ratios

showed significance.

The t tests performed on the performance ratio model H1t-3 showed 11

performance ratios were not significant when the fraud and no fraud groups were

compared. Of the two variables found not to be significant in both H1t-1 and H1t-2,

ELNANTR was found not significant in H1t-3, fraud (M = 344.08, SD = 1101.61), no fraud

(M = 133.64, SD = 734.17), t(245) = -1.76, p = .08 (two-tailed), and NIMY was found

significant, fraud (M = 4.76, SD = 1.40), no fraud (M = 4.44, SD = 1.05), t(264) = -2.09, p

= .04 (two-tailed). The variable IDDIVNR that was not significant in H1t-1 was also not

significant in H1t-3, fraud (M = 33.25, SD = 39.69), no fraud (M = 35.49, SD = 45.33),

t(263) = .43, p = .67 (two-tailed). The performance ratio variable LNLSDEPR that was

not significant in H1t-1, was also not significant at H1t-3, fraud (M = 71.85, SD = 15.75),

no fraud (M = 68.44, SD = 34.08) t(264) = -1.05, p = .30 (two-tailed).

Growth Ratio Model H2

Descriptive statistics for the growth ratio model H2 consisted of the means,

standard deviation, standard error means, and number of observations (see Appendix D).

All t test results for the growth ratio model H2 are included in Appendix E. The t tests
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performed on the growth ratio model H2t-1 showed two out of four growth ratios were not

significant. The two other growth ratios showed significance. The growth ratios that did

not have significance between the fraud and no fraud groups were ROLLS5TA growth

ratio 1, fraud (M = .77, SD = .15), no fraud (M = .73, SD = .20), t(264) = -1.42, p = .16

(two-tailed) and ROVLTA growth ratio 2, fraud (M = .13, SD = .09), no fraud (M = .12,

SD = .07), t(264) = -1.60, p = .11 (two-tailed).

The t tests performed on the growth ratio model H2t-2 showed that the four growth

ratios were significant when the fraud and no fraud groups were compared. The t tests

performed on the growth model H2t-3 showed that three growth ratios were significant

when the fraud and no fraud groups were compared. The two variables found not to be

significant in H2t-1, ROLLS5TA growth ratio 1 and ROVLTA growth ratio 2 were found

significant in H2t-2. The only growth ratio to show no significance in H2t-3 was

ROLLPS5TA growth ratio 1, fraud (M = .75, SD = .15), no fraud (M = .71, SD = .21),

t(264) = -1.86, p = .06 (two-tailed).

Capital Ratio Model H3

Descriptive statistics for the capital ratio model H3 includes the means, standard

deviation, standard error means, and number of observations (see Appendix D). All t test

results for the capital ratio model H3 are included in Appendix E. The t tests performed

on the independent variables in the capital ratio model H3 showed all capital ratios were

significant in all time intervals, H3t-1, H3t-2, and H3t-3.

Findings

The null hypotheses were tested within the logistic regression model formula by

setting the logit coefficient (Bk) equal to zero, providing a benchmark for the alternative
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hypotheses to be tested. The logistic regression model sample was split evenly between

fraud and no fraud community banks. Randomness dictates that the null hypotheses

predict a correct outcome 50% of the time. As shown in Table 10, the logistic regression

testing of the null hypotheses confirms such outcome.

The number of missing cases in each data set accounts for the variation within the

outcomes of the percentage of accuracy classification. In the performance ratio Null

Hypothesis H10(t-1), there were 114 no fraud community banks and 128 fraud community

banks. In the performance ratio Null Hypothesis H10(t-2), there were 113 no fraud

community banks and 125 fraud community banks. In the performance ratio Null

Hypothesis H10(t-3), there were 116 no fraud community banks and 122 fraud community

banks. In the growth ratio Null Hypotheses H20(t-i), there were 132 no fraud community

banks and 133 fraud community banks. In the capital ratio Null Hypotheses H30(t-i), there

were 133 no fraud community banks and 133 fraud community banks.

The SPSS logistic regression software tested the significance of each alternative

hypothesis model producing a chi-square statistic, degrees of freedom, and a significance

value (p < 0.05) as shown in Table 11. At all time intervals, the alternative hypotheses

were found significant at the level of p < 0.0005. The result means that the logistic

regression formula instrument for all hypotheses was better at predicting the likely

outcome than the null hypotheses had significance. At each time interval, the

performance ratio model H11 produced a higher chi-square statistic. The performance

ratio model H11 indicated a better overall goodness-of-fit than either the growth ratio

model H21 or the capital ratio model H31.


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Table 10

Null Hypotheses Analysis

Null Hypotheses Cases Missing Percent Percentage Accuracy

Cases Missing Classification

Performance Ratio Model H10(t-1) 266 24 9% 52.9%

Performance Ratio Model H10(t-2) 266 28 10.5% 52.5%

Performance Ratio Model H10(t-3) 266 28 10.5% 51.3%

Growth Ratio Model H20(t-1) 266 1 0.4% 50.2%

Growth Ratio Model H20(t-2) 266 1 0.4% 50.2%

Growth Ratio Model H20(t-3) 266 1 0.4% 50.2%

Capital Ratio Model H30(t-1) 266 0 0% 50.0%

Capital Ratio Model H30(t-2) 266 0 0% 50.0%

Capital Ratio Model H30(t-3) 266 0 0% 50.0%

Table 11

Overall Model Fit of Alternative Hypotheses

Alternative Hypotheses Chi-square df p

Performance Ratio Model H11(t-1) 71.08 19 .000*

Performance Ratio Model H11(t-2) 83.98 19 .000*

Performance Ratio Model H11(t-3) 57.89 19 .000*

Growth Ratio Model H21(t-1) 32.65 4 .000*

Growth Ratio Model H21(t-2) 42.39 4 .000*

Growth Ratio Model H21(t-3) 33.98 4 .000*


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Table 11 (Continued)

Capital Ratio Model H31(t-1) 24.58 4 .000*

Capital Ratio Model H31(t-2) 26.84 4 .000*

Capital Ratio Model H31(t-3) 23.90 4 .000*

Note: * Significant p < .0005

Cox & Snell R2 and Nagelkerke R2 tests were performed at all time intervals for

the alternative hypotheses (see Table 12). The Cox & Snell R2 and Nagelkerke R2 tests

provided a pseudo R2 statistic to analyze the approximate amount of variation of the

dependent variable, fraud or no fraud, explained in the alternative hypotheses at each

time interval. An additional goodness-of-fit test, the Homer and Lemeshow goodness-of-

fit test, was performed to test how well the logistic regression model performed relative

to the null hypotheses. In the Homer and Lemeshow goodness-of-fit, significance is

measured as p > .05 (Pallant, 2007). In logistic regression analysis, multiple measures of

model fit are used to find a convergence of indicators of model fit to support the research

results (Hair et al., 2006).

In all time intervals, the performance ratio model H11 showed an increased ability

in explaining the variations in the dependent variable. Two time intervals of the growth

ratio model, H21(t-1) and H21(t-3), showed an increased ability in explaining the variations

in the dependent variable than the null hypothesis but to a lesser degree than found in the

performance ratio model H11. The H21(t-2) hypothesis produced a Homer and Lemeshow

goodness-of-fit score of 0.03 where p > .05. This indicated that the H21(t-2) model

produced a poor fit and should be rejected.

All time intervals of the capital ratio models, H31(t-1), H31(t-2), and H31(t-3), showed

ability in explaining some of the variations in the dependent variable but only to a smaller
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degree than H11 and H21. Table 12 shows the results for Cox & Snell R2, the Nagelkerke

R2, and the Homer and Lemeshow tests, for all the hypotheses. The performance ratio

model H11(t-2) showed the greatest explanation of between 29.7% and 39.7% of the

variation in the dependent variable.

Table 12

Alternative Hypotheses Model Summaries

-2 Log Cox & Snell Nagelkerke Homer and

Alternative Hypotheses likelihood R2 R2 Lemeshow

R2

Performance Ratio Model H11(t-1) 263.59 .25 .34 .63

Performance Ratio Model H11(t-2) 245.35 .30 .40 .24

Performance Ratio Model H11(t-3) 271.90 .22 .29 .52

Growth Ratio Model H21(t-1) 334.71 .12 .16 .34

Growth Ratio Model H21(t-2) 324.97 .15 .20 .03*

Growth Ratio Model H21(t-3) 333.39 .12 .16 .49

Capital Ratio Model H31(t-1) 344.18 .09 .12 .63

Capital Ratio Model H31(t-2) 341.92 .10 .13 .11

Capital Ratio Model H31(t-3) 344.85 .09 .11 .82

* Not significant p < .05

The percentage of accuracy classification table (see Table 13) shows the ability of

each logistic regression model to predict accurately the correct outcome. The percentage

accuracy classification table is divided into an overall percentage of accuracy, a no fraud

predictive accuracy percentage, and a fraud predictive accuracy percentage. The


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performance ratio models had a higher overall accuracy classification than either the

growth ratio models or the capital ratio models.

The capital ratio model all showed a poor ability to predict correctly a no fraud

community bank at .52 for all time intervals. This result is only slightly better than the

.50 for the null hypothesis. The performance ratio model for H11(t-2) had the highest

percentage of accuracy classification at 74% with both the ability to predict accurately

fraud or no fraud banks at 74%.

Table 13

Percentage Accuracy Classification

Percentage Percentage Percentage

Accuracy Correct Correct

Alternative Hypotheses Classification No Fraud = 0 Fraud = 1

Performance Ratio Model H11(t-1) .73 .73 .73

Performance Ratio Model H11(t-2) .74 .74 .74

Performance Ratio Model H11(t-3) .70 .71 .68

Growth Ratio Model H21(t-1) .62 .55 .68

Growth Ratio Model H21(t-2) .65 .60 .71

Growth Ratio Model H21(t-3) .64 .61 .68

Capital Ratio Model H31(t-1) .63 .52 .75

Capital Ratio Model H31(t-2) .64 .52 .76

Capital Ratio Model H31(t-3) .65 .52 .77


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The performance ratio model H11 showed the best overall fit of the three

alternative hypotheses. In all comparisons of the logistical regression analysis, the

performance ratio models H11 showed the highest chi-square value. This result was

confirmed by the performance ratio models H11 having the highest percentage accuracy

classification and by the pseudo R2 tests.

Analysis of Logistical Coefficients

The logistical regression formula instrument was run on each alternative

hypothesis, H11, H21, and H31, of the logistical regression model. The model analyzed

data from a 1, 2, and 3-year intervals from the occurrence of management fraud on all

three hypothesis of the logistical model. The procedure produced nine iterations of the

logistical regression formula instrument, H11(t-1), H11(t-2), H11(t-3), H21(t-1), H21(t-2), H21(t-3),

H31(t-1), H31(t-2), H31(t-3). Within each logistic regression iteration, the independent

variables were examined for significance in predicting the outcome of the dependent

variable.

Analysis of the logistic regression coefficients indicates evidence of

multicollinearity. Colllinearity or multicollinearity is the correlation between one or more

of the independent variables (Hair et al., 2006). The high level of nonsignificant variables

contained in logistic regression models with significance is an indication of possible

multicollinearity. It is common to find multicollinearity in a study using economic and

financial data (Hair et al., 2006).

Many financial ratios used in the study have common or derivative denominators,

increasing the likelihood of multicollinearity. Multicollinearity in regression coefficients

does not affect the significance or validity of the model (Hair et al., 2006).
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Multicollinearity occurs in degrees, raising doubts concerning the relationship between

the variables and the ability to draw conclusions concerning individual variables.

Perfect collinearity violates the underlying assumptions of logistical regression.

Lesser degrees of collinearity are less predictable as to the effect on regression

coefficients significance. The SPSS statistical program calculates two collinearity

statistics, tolerance and the variance inflation factor [VIF]. Tolerance factors of .10 or

less generally indicates collinearity as does a VIF of 10 or greater.

Appendix H provides the levels of tolerance and VIF for each iteration of H11. All

logistic regression models were tested for the degree of collinearity. Where high degrees

of collinearity existed, additional testing was conducted to examine and resolve the

collinearity effects. In cases of collinearity, one of the correlated variables are deleted

from the model, and the model is rerun (Hair et al., 2006).

Performance Ratios

Hypothesis H11 involved performance ratios.

H11: Community banks with poor performance ratios have an increased

occurrence of management fraud in subsequent years.

To test the Hypothesis H11, the logistic regression model formula was applied to

the hypothesis. This was accomplished by using the logistical regression formula

instrument and substituting the performance ratio variables listed in Table 4 as X1(t-y) . . .

Xk(t-y). H11 then tested the effects of performance ratios in predicting the occurrence of

management fraud.

All three time intervals for H11 were significant at p < .001, as stated in Table 11.

In the logistical regression analysis of the performance ratio model H11(t-1), no


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independent variables were significant in predicting the outcome of fraud or no fraud. In

performance ratio model H11(t-2), 3 of 20 independent variables showed significance in

contributing to the prediction of the outcome. In performance ratio model H11(t-3), 4 of 20

independent variables showed significance in contributing to the prediction of the

outcome. The three independent variables identified in H11(t-2) were found significant in

H11(t-3), and a fourth independent variable of significance was identified.

The SPSS software in the logistical regression calculations excluded the variable

NIMY net interest margin as redundant. NIMY is the difference between variables

INTINCY yield on earning assets and INTEXPY cost of funding assets (NIMY = INTNCY

– INTEXPY). All other variables were incorporated into the logistic regression model.

Performance Ratio Model H11(t-1)

The first test of the performance ratio model was for H11(t-1). The findings showed

that the model containing all performance ratio variables was statistically significant

χ2(20, N = 242) = 71.08, p > .001 where χ2 is the computed chi-square value, N is total

sample size, and p is the probability. The tests indicated that the performance ratio model

H11(t-1) could distinguish the difference between community banks where fraud occurred.

The Cox & Snell R2 and the Nagelkerke R2 estimated that the performance ratio

model H11(t-1) explains 25.4% to 34% of the change in the dependent variable in a

significant manner. The prediction accuracy classification for the performance ratio

model for H11(t-1) was 73.1%. The result indicates a strong model fit for performance

ratio model H11(t-1).

The details of the logistic regression analysis for H11(t-1) are included in Appendix

G. When looking at the contribution of individual independent variables in the


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performance ratio model H11(t-1), no independent variables were significant at p < .05.

The result indicates that, while the model has improved accuracy in classifying which

community banks had an occurrence of fraud, it cannot be stated that any independent

variable contributed in a significant manner to the increased accuracy.

The tolerance and VIF for all three time intervals of H1 are in Appendix H.

Tolerance factors of .1 or less and VIFs of 10 or greater were found in 8 of the 19

variables in the performance ratio logistic regression model H11(t-1). The result is an

indication of possible multicollinearity between variables that leads to questioning the

reliability of the levels of significance of independent variables in the model.

Performance Ratio Model H11(t-2)

The second test of the performance ratio model was at H11(t-2). The findings show

that model containing all performance ratio variables was statistically significant, χ2(20,

N = 238) = 83.98, p > .001, indicating that the performance ratio model for H11(t-2) could

distinguish the difference between community banks where fraud occurred. The Cox &

Snell R2 and the Nagelkerke R2 estimated that the performance ratio model H11(t-2)

explains 29.7% to 39% of the change in the dependent variable in a significant manner.

The prediction accuracy classification of performance ratio model H11(t-2) was 74.4%.

The result indicates a stronger model fit for the performance ratio model H11(t-2) than was

observed for H11(t-1).

The details of the logistic regression coefficients for H11(t-2) are detailed in

Appendix I. When looking at the contribution of individual independent variables in the

performance ratio model H11(t-2), three independent variable were significant, NTLNLSR

net charge-offs to loans, ASTEMPM assets per employee, and IDLNCORR net loans and
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leases to core deposits. The independent variables NTLNLSR and IDLNCORR had odds

ratio of 3.36 and 1.05.

For every unit of increase in the independent variable, the odds ratios indicate the

likelihood of a 1-unit increase in the dependent variable. The independent variable

ASTEMPM had an odds ratio of .48 and a B value of -.74. When the odds ratios are less

than 1 and the B value is negative, the odds are inverted in interpretation (Pallant, 2007).

In the case of ASTEMPM, a 1-unit increase in the independent variable decreases the

likelihood of a 1-unit change in the dependent variable, likelihood of fraud.

The tolerance and VIF for all three time intervals of H1 are in Appendix H.

Tolerance factors of .1 or less and VIFs of 10 or greater were found in 7 of the 19

variables in the performance ratio logistic regression model H11(t-1). The result is an

indication of possible multicollinearity between variables that leads to questioning the

reliability of the levels of significance of independent variables in the model.

Performance Ratio Model H11(t-3)

The third test of the performance ratio model was for H11(t-3). The findings show

that the model containing all performance ratio variables was statistically significant,

χ2(20, N = 238) = 57.89, p > .001, indicating that the performance ratio model for H11(t-3)

could distinguish the difference between community banks where fraud occurred. The

Cox & Snell R2 and the Nagelkerke R2 measures estimated that the performance ratio

model for H11(t-3) explains 21.6% to 28.8% of the change in the dependent variable in a

significant manner. The prediction accuracy classification for the performance ratio

model H11(t-3) was 69.3%. The performance ratio model H11(t-3) showed strong model fit,

but it was less than the overall fit of H11(t-2).


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The details of the logistic regression coefficients for H11(t-3) are included in

Appendix J. When looking at the contribution of individual independent variables in the

performance ratio model H11(t-3), four independent variables are significant to p < .05.

They are ROA return on assets, NTLNLSR net charge-offs to loans, ASTEMPM assets per

employee, and IDLNCORR net loans and leases to core deposits contributed. The

independent variables ROA, NTLNLSR, and IDLNCORR had odds ratio of 20.24, 2.83,

and 1.09.

For every unit of increase in the independent variable, the odds ratios indicate the

likelihood of a 1-unit increase in the dependent variable. The independent variable

ASTEMPM had an odds ratio of .51 and a B value of -.68. When the odds ratios are less

than 1, the odds are inverted in interpretation (Pallant, 2007). In the case of ASTEMPM, a

1-unit increase in the independent variable decreases the likelihood of a 1-unit change in

the dependent variable, likelihood of fraud.

The tolerance and VIF for all three time intervals of H1 are in Appendix H.

Tolerance factors of .1 or less and VIFs of 10 or greater were found in 9 of the 19

variables in the performance ratio logistic regression model H11(t-3). The result is an

indication of possible multicollinearity between variables that leads to questioning the

reliability of the levels of significance of independent variables in the model.

Revised Performance Ratio Model H12

The existence of multicollinearity in the performance ratio model raised questions

of the significance found in analysis of the regression coefficients. Testing was conducted

to determine the extent of the collinearity between coefficients. The SPSS software

provided collinearity diagnostics of tolerance and VIF levels for the variables in the
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performance ratio model (Appendix H). Correlation matrices for all performance ratios

variables used in the logistic regression model are in Appendix K.

The correlation matrices indicate five pairs or groups of variables that exhibited

high levels of correlation. Four of the groupings consisted of a pair of variables, each

measuring a similar relationship in a financial statement. One group consisted of five

variables, each measuring a relationship between income, or a subset of income, and

earning assets. Using a trial and error approach, one variable from each correlated set of

variables was selected to represent the correlated financial statement relationship and the

performance ratio logistic regression model was rerun. A new performance ratio model,

H12, was developed. The new performance ratio model contained nine performance ratio

variables as listed in Table 14.

Table 14

New Performance Ratio Model H12 Variables

Variable Name

ASTEMPM Assets per employee

ELNANTR Credit loss provision to net charge-offs

IDDIVNIR Cash dividends to net income

IDLNCORR Net loans and leases to core deposits

INRESNCR Loan loss allowance to non-current loans

INTEXPY Cost of funding assets

NCLNLSR Noncurrent loans to loans

NOIJY Net operating income to assets

NTLNLSR Net charge-offs to loans


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The tolerance and VIF for the three time intervals of H12 are in Table 15.

Tolerance factors of .1 or less and VIFs of 10 or greater were not found in any of the

variables in the new performance ratio logistic regression model H12. The result is an

indication of little multicollinearity between variables in the model.

Table 15

Tolerance and VIF Levels in H12

Variables H12(t-1) H12(t-2) H12(t-3)

Tolerance VIF Tolerance VIF Tolerance VIF

ASTEMPM .94 1.06 .81 1.23 .86 1.16

ELNANTR .99 1.01 .97 1.03 .97 1.03

IDDIVNIR .94 1.07 .91 1.10 .93 1.08

IDLNCORR .91 1.10 .74 1.36 .64 1.57

INRESNCR .95 1.05 .88 1.13 .92 1.09

INTEXPY .86 1.16 .61 1.64 .60 1.68

NCLNLSR .57 1.74 .57 1.75 .62 1.60

NOIJY .25 3.95 .63 1.59 .67 1.49

NTLNLSR .35 2.86 .62 1.64 .65 1.54

The findings for H12 show that model was statistically significant at H12(t-1),

χ2(10, N = 242) = 61.26, p > .001, at H12(t-2), χ2(10, N = 238) = 67.10, p > .001, and χ2(10,

N = 238) = 41.84, p > .001, at H12(t-3). The result indicates that the new performance ratio

model could distinguish the difference between community banks where fraud occurred

at all time intervals. The Cox & Snell R2 and the Nagelkerke R2 estimated that the new
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performance ratio model H12 explains 22.4% to 29.9% of the change in the dependent

variable in a significant manner at H12(t-1), 24.6% to 32.8% at H12(t-2), and 16.1% to

21.5% at H12(t-3). The prediction accuracy classification for the new performance ratio

model for H12 was 70.7% at H12(t-1), 73.1% at H12(t-2), and 68.5% at H12(t-3). The result

indicates a strong model fit for the new performance ratio model H12. Table 16 provides

a comparative view of H11 and H12.

Table 16

Comparative Model Fit of H11 and H12

Cox & Percentage

Snell Nagelkerke Homer & Accuracy

Hypotheses χ2 df p R2 R2 Lemeshow Classification

H11(t-1) 71.08 19 .001* .25 .34 .63 .73

H11(t-2) 83.98 19 .001* .30 .40 .40 .74

H11(t-3) 57.89 19 .001* .22 .29 .29 .68

H12(t-1) 61.26 10 .001* .22 .30 .46 .71

H12(t-2) 67.10 10 .001* .25 .33 .26 .73

H12(t-3) 41.84 10 .001* .16 .21 .61 .69

Note: * Significant p < .0005

When looking at the contribution of individual independent variables in the

performance ratio model H12, variables IDLNCORR and ASTEMPM were significant at p

< .05 in the three time intervals. Variable NTLNLSR was significant, p < .05, in time

interval H12(t-1) and H12(t-2). NTLNLSR was significant, p < .10, in time interval H12(t-3).

The three variables found significant in H12 were found significant in H11(t-2) and H11(t-3).
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The B values and odds ratios for NTLNLSR net charge-offs to loans, ASTEMPM assets

per employee, and IDLNCORR net loans and leases to core deposits are in Table 17.

For every unit of increase in the independent variable, the odds ratios indicate the

likelihood of a 1-unit increase in the dependent variable. When the odds ratios are less

than 1, the odds are inverted in interpretation (Pallant, 2007). A 1-unit increase in the

independent variable decreases the likelihood of a 1-unit change in the dependent

variable, likelihood of fraud.

Table 17

Odds Ratios for H12 Significant Variables

Variables H12(t-1) H12(t-2) H12(t-3)

B - value Odds Ratio B - value Odds Ratio B – value Odds

Ratio

ASTEMPM -.50 .60 -.65 .52 -.60 .55

IDLNCORR .02 1.02 .03 1.03 .03 1.03

NTLNLSR .72 2.05 1.25 3.50 .47 1.60

Growth Ratios

Hypothesis H21 involved growth ratios.

H21: Community banks with high growth ratios have an increased occurrence of

management fraud in subsequent years.

To test Hypothesis H21, the logistic regression model formula was applied to the

hypothesis. This was accomplished by using the logistical regression formula instrument

and substituting the growth ratio variables listed in Table 5 as X1(t-y) . . . Xk(t-y). H21 then

tested the effects of the growth ratios in predicting the occurrence of management fraud.
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In the growth ratio model, all three models were significant in the overall

goodness-of-fit test as stated in Table 11. The growth ratio model H21(t-2) was found not

significant in the additional Homer and Lemeshow goodness-of-fit test. In the logistical

regression analysis of the growth ratio model H21(t-1), three independent variables were

found to be significant in predicting the outcome of fraud or no fraud. In growth ratio

model H21(t-3), the three independent variables identified in growth ratio model H21(t-1)

were also found significant.

Growth Ratio Model H21(t-1)

The findings show that model H21(t-1) containing all growth ratio variables was

statistically significant χ2(4, N = 265) = 32.65, p > .001, indicating that the growth ratio

model for H21(t-1) could distinguish the difference between community banks where fraud

occurred. The Cox & Snell R2 and the Nagelkerke R2 estimated that the growth ratio

model for H21(t-1) explains 11.6% to 15.5% of the change in the dependent variable in a

significant manner. The prediction accuracy classification showed that the growth ratio

model for H21(t-1) was 61.9%. The result indicates that growth ratio model H21(t-1) showed

model fit and the ability to explain the variations of the dependent variable but to a lesser

degree than the performance ratio models H11 or H12.

When looking at the contribution of individual independent variables in the

growth ratio model H21(t-1) in Table 18, three independent variables are significant to p <

.05, ROVLTA ratio of volatile liabilities to assets, ASTEMPM assets per employee, and

EQV equity capital to assets. The independent variables ROVLTA had an odds ratio of

42.86. The independent variable ASTEMPM and EQV had an odds ratio of .53 and .90,

and B values of -.63 and -.10. When the odds ratios are less than 1 and the B values are
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negative, the odds are inverted in interpretation (Pallant, 2007). In the case of ASTEMPM

and EQV, a 1-unit increase in the independent variable decreases the likelihood of a 1-

unit change in the dependent variable, likelihood of fraud.

Table 18

Description of Variables in Growth Ratio Model H21(t-1)

95.0% C.I. for

Odds Ratio

Odds

Variables B SE Wald df P Ratio Lower Upper

ROLLPS5TA 1.24 .81 2.33 1 .12 3.45 .70 16.90

ROVLTA 3.87 1.80 4.59 1 .03 47.82 1.39 1642.46

ASTEMPM -.64 .16 15.81 1 .00 .53 .39 .73

EQV -.10 .04 5.07 1 .02 .91 .83 .99

Constant 1.18 .80 2.17 1 .14 3.26

The tolerance and VIF for H2(t-1) are in Table 19. Tolerance factors of .1 or less

and VIFs of 10 or greater were not found in any variables in the growth ratio logistic

regression model H21(t-1). This is an indication of little multicollinearity between the

independent variables in the model.


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Table 19

Tolerance and VIF Levels in H21(t-1)

Variables Tolerance VIF

ROLLPS5TA .89 1.12

ROVLTA .92 1.08

ASTEMPM .84 1.19

EQV .89 1.12

Growth Ratio Model H21(t-2)

The second test of the growth ratio model was for H21(t-2). The findings show that

model containing all growth ratio variables was statistically significant χ2 (4, N = 265) =

42.39, p > .001, indicating that the growth ratio model for H21(t-2) could distinguish the

difference between community banks where fraud occurred. The Cox & Snell R2 and the

Nagelkerke R2 estimated that the growth ratio model for H21(t-2) explains 14.8% to 19.7%

of the change in the dependent variable in a significant manner. The prediction accuracy

classification showed that the growth ratio model for H21(t-2) was 65.3%. There were

contradictory statistics for the growth ratio model for H21(t-2). A second goodness-of-fit

measure, the Homer and Lemeshow test, indicated a level of significance of .03, p > .05,

indicating that the null hypothesis should not be ruled out.

Growth Ratio Model H21(t-3)

The third test of the growth ratio model was for H21(t-3). The findings show that

the model containing all growth ratio variables was statistically significant χ2(4, N = 265)

= 33.98, p > .001, indicating that the growth ratio model for H21(t-3) could distinguish the

difference between community banks where fraud occurred. The Cox & Snell R2 and the
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Nagelkerke R2 estimated that the growth ratio model for H21(t-3) explains 12% to 16% of

the change in the dependent variable in a significant manner. The prediction accuracy

classification showed that the growth ratio model for H21(t-3) was 64.2%. While this

indicates a model fit, the model has a lesser fit relative to the performance ratio models

H11. and H12.

When looking at the contribution of individual independent variables in the

growth ratio model H21(t-3) in Table 20, three independent variable are significant to p <

.05, ROVLTA ratio of volatile liabilities to assets, ASTEMPM assets per employee, and

EQV equity capital to assets. The independent variables ROVLTA had an odds ratio of

542.69. For every unit of increase in the independent variable, the odds ratios indicate the

likelihood of a 1-unit increase in the dependent variable. The independent variable

ASTEMPM and EQV had an odds ratio of .59 and .88, and B values of -.53 and -.13.

When the odds ratios are less than 1, the odds are inverted in interpretation (Pallant,

2007). In the case of ASTEMPM and EQV, a 1-unit increase in the independent variable

decreases the likelihood of a 1-unit change in the dependent variable, likelihood of fraud.

The tolerance and VIF for H21(t-3) are in Table 21. Tolerance factors of .1 or less

and VIFs of 10 or greater were not found in any variables in the growth ratio logistic

regression model H21(t-3). The result is an indication of little multicollinearity between the

independent variables in the model.


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Table 20

Description of Variables in Growth Ratio Model H21(t-3)

95.0% C.I. for

Odds Ratio

Odds

Variables B SE Wald df P Ratio Lower Upper

ROLLPS5TA 1.41 .83 2.88 1 .09 4.08 .81 20.69

ROVLTA 6.30 1.93 10.61 1 .00 542.69 12.28 23975.05

ASTEMPM -.53 .16 10.99 1 .00 .59 .43 .81

EQV -.13 .05 7.48 1 .01 .88 .80 .97

Constant .76 .78 .95 1 .33 2.14

Table 21

Tolerance and VIF Levels in H21(t-3)

Variables Tolerance VIF

ROLLPS5TA .86 1.16

ROVLTA .94 1.06

ASTEMPM .85 1.18

EQV .90 1.12

Capital Ratio Model

Hypothesis H31 involved capital ratios.

H31: Community banks with poor capital ratios have an increased occurrence of

management fraud in subsequent years.


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The H31 logistic regression model formula was applied to the hypothesis by using

the logistical regression formula instrument and substituting the capital ratio variables

listed in Table 6 as X1(t-y) . . . Xk(t-y). H31 then tested the effects of the capital ratios in

predicting the occurrence of management fraud. All three capital ratios models were

significant in the overall goodness-of-fit test as stated in Table 10. In logistical regression

analysis of the capital ratio model H31, no independent variables in any time intervals

were significant in predicting the outcome of fraud or no fraud. All capital ratio models

showed only a marginal ability to predict a no fraud community bank outcome.

Capital Ratio Model H31(t-1)

The first test of the capital ratio model was for H31(t-1). The findings show that

model containing all capital ratio variables were statistically significant χ2(20, N = 266) =

24.58, p > .001, indicating that the capital ratio model for H31(t-1) could distinguish the

difference between community banks where fraud occurred. The Cox & Snell R2 and the

Nagelkerke R2 measures estimated that the capital ratio model for H31(t-1) explains 8.8%

to 11.8% of the change in the dependent variable in a significant manner.

The prediction accuracy classification for the capital ratio model H31(t-1) was

63.5%. The capital ratio model H31(t-1) provided improved model fit than the null

hypotheses, but it is weaker than the model fit shown by the performance ratio model H11

H22. The contributions of individual independent variables in the capital ratio model

H31(t-1) in Table 22 show no independent variables that are significant to p < .05.
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Table 22

Description of Variables in Capital Ratio Model H31(t-1)

95.0% C.I. for

Odds Ratio

Odds

Variables B SE Wald df P Ratio Lower Upper

EQV .17 .14 1.42 1 .23 1.19 .90 1.58

RBC1AAJ -.25 .17 2.32 1 .13 .78 .56 1.08

RBC1RWAJ -.48 .43 1.23 1 .27 .62 .27 1.44

RBCRWAJ .42 .43 .96 1 .33 1.52 .66 3.53

Constant 1.11 .64 3.04 1 .08 3.05

The tolerance and VIF for H31(t-1) are in Table 23. Tolerance factors of .1 or less

and VIFs of 10 or greater were found in all variables in the capital ratio logistic

regression model H31(t-1). This is an indication of possible multicollinearity between

variables that leads to questioning the reliability of the levels of significance of the

independent variables in the model.

Table 23

Tolerance and VIF Levels in H31(t-1

Variables Tolerance VIF

EQV .02 46.04

RBC1AAJ .02 48.99

RBC1RWAJ .001 979.09

RBCRWAJ .001 964.08


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Capital Ratio Model H31(t-2)

The findings for capital ratio model H31(t-2) show that the model containing all

capital ratio variables was statistically significant χ2(20, N = 266) = 26.84, p > .001,

indicating that the capital ratio model H31(t-2) could distinguish the difference between

community banks where fraud occurred. The Cox & Snell R2 and the Nagelkerke R2

measures estimated that the capital ratio model for H31(t-2) explains 9.6% to 12.8% of the

change in the dependent variable in a significant manner. The prediction accuracy

classification for the capital model H31(t-2) was 63.5%. The contribution of individual

independent variables in the capital ratio model H31(t-2) in Table 24 shows that no

independent variables are significant to p < .05.

Table 24

Description of Variables in Growth Ratio Model H31(t-2)

95.0% C.I. for

Odds Ratio

Odds

Variables B SE Wald df P Ratio Lower Upper

EQV .13 .20 .45 1 .51 1.14 .77 1.68

RBC1AAJ -.17 .21 .67 1 .41 .84 .56 1.27

RBC1RWAJ -.20 .46 .19 1 .66 .82 .33 2.02

RBCRWAJ .12 .46 .07 1 .80 1.13 .46 2.78

Constant 1.53 .67 5.21 1 .02 4.63


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The tolerance and VIF for H31(t-2) are in Table 25. Tolerance factors of .1 or less

and VIFs of 10 or greater were found in all variables in the capital ratio logistic

regression model H31(t-2). This is an indication of possible multicollinearity between

variables that leads to questioning the reliability of the levels of significance of the

independent variables in the model.

Table 25

Tolerance and VIF Levels in H31(t-2)

Variables Tolerance VIF

EQV .01 76.42

RBC1AAJ .01 83.83

RBC1RWAJ .001 1134.41

RBCRWAJ .001 1114.74

Capital Ratio Model H31(t-3)

The third test of the capital ratio model was for H31(t-3). The findings show that

the model containing all capital ratio variables was statistically significant χ2(20, N =

266) = 26.84, p > .001, indicating that the capital ratio model for H31(t-3) could distinguish

the difference between community where fraud occurred. The Cox & Snell R2 and the

Nagelkerke R2 measures estimated that the capital ratio model for H31(t-3) explains 9.6%

to 12.8% of the change in the dependent variable in a significant manner. The prediction

accuracy classification for the capital ratio model H31(t-3) was 63.5%. When looking at the

contribution of individual independent variables in the capital ratio model H31(t-3) in

Table 26, there are no independent variables that are significant to p < 0.05.
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Table 26

Description of Variables in Capital Ratio Model H31(t-3)

95.0% C.I. for

Odds Ratio

Odds

Variables B SE Wald df P Ratio Lower Upper

EQV .31 .20 2.37 1 .12 1.37 .92 2.04

RBC1AAJ -.30 .19 2.61 1 .11 .74 .51 1.07

RBC1RWAJ .18 .44 .16 1 .69 1.19 .50 2.83

RBCRWAJ -.25 .44 .33 1 .57 .78 .33 1.84

Constant 1.45 .64 5.22 1 .02 4.27

The tolerance and VIF for H31(t-3) are in Table 27. Tolerance factors of .1 or less

and VIFs of 10 or greater were found in all variables in the capital ratio logistic

regression model H31(t-3). This is an indication of possible multicollinearity between

variables that leads to questioning the reliability of the levels of significance of the

independent variables in the model.

Table 27

Tolerance and VIF Levels in H31(t-3)

Variables Tolerance VIF

EQV .01 72.40

RBC1AAJ .01 74.24

RBC1RWAJ .001 1162.02

RBCRWAJ .001 1151.93


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Validity and Outliers

Validity of the data is central to the ability to infer results and generalize

outcomes to other groups. In logistic regression, validation is tested by separating the

sample into two groups of matched pairs and comparing the results of different measures.

Two measures were used in testing validity. The first measure entailed separating the

sample into two subsamples and comparing the percentage of accuracy classification. The

comparison was conducted of all alternative hypotheses at the different time intervals.

Appendix L provides details of the validity comparisons of the subsamples. In all

alternative hypotheses models, all percentage of accuracy classifications were sufficiently

larger than the null hypotheses benchmark of 50%.

The second test of validity conducted was validation lift. In validation lift, the

logistical regression model results of each case are in percentile formats of a positive

result. In validation lift, the higher percentiles should represent a greater proportion of the

positive outcomes. Appendix M provides details of the validation lift measures of the

alternative hypotheses in all time intervals. All alternative hypotheses showed acceptable

levels of lift. The performance ratio model H1 showed the highest level of validation

based upon the lift in the highest percentiles.

Each of the alternative hypotheses, in each of the time interval, showed cases

outside of two standard deviations beyond the mean as shown in Table 28. The

performance ratio model H1 had the most outliers with five at H11(t-1), three at H11(t-2),

and three at H11(t-3). As detailed in Appendix N, the outliers in the model produced high

residuals or errors in predicting the observed and predicted outcome (Hair et al., 2006).
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Table 28

Number of Outliers by Hypothesis

Number of

outliers

Hypothesis Number of cases t-1 t-2 t-3

Performance Ratio Model H1 266 5 3 3

Growth Ratio Model H2 266 1 1 1

Capital Ratio Model H3 266 1 2 1

All outlier cases were examined for anomalous data or unusual case histories, and

none was observed. The growth ratio model H2 had one outlier at each of the time

intervals. The capital ratio model had 1 outlier at H31(t-1), 2 at H31(t-2), and 1 at H31(t-3). As

detailed in Appendix O, the method of determining the effect of outliers on the logistical

regression model is to compare the results of the logistical regression with the outlier in

the model and without the outliers in the model. In all alternative hypotheses, in all time

intervals, the outliers had no material impact upon the logistical regression model.

Summary

Descriptive statistical tests were conducted on the matched pairs sample.

Comparisons of the variances between the groups of fraud and no fraud community

banks indicated the significant differences for most variables. The logistic regression

model formulas tested the null hypotheses and provided a benchmark for the alternative

hypotheses. The logistic regression formula instrument for all alternative hypotheses was

better at predicting the likely outcome than the null hypotheses in a significant manner.
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The performance ratio model H11 of the logistical regression formula instrument

showed the highest level of model fit and predictive accuracy. The performance ratio

model showed evidence of multicollinearity. Additional testing eliminated

multicollinearity from the performance ratio model, producing a new performance ratio

model, H12.

The new performance ratio model H12 showed high levels of model fit and

predictive accuracy and found three out of nine independent variables significant. The

growth ratio model H21 of the logistical regression formula instrument produced

inconsistent results. The capital ratio model H31 of the logistical regression formula

instrument produced marginal predictive results.

Chapter 5 includes a discussion of the logistical regression model and the findings

with a review of the research problem, purpose, and research methods in light of the

findings. The discussion addresses the limitations of the study, inferences, and the

significance of the study to the field of leadership. The discussions lead to conclusions,

statements of implications, and recommendations for further research.


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CHAPTER 5: CONCLUSION AND RECOMMENDATIONS

The misbehavior of managers and leaders within an organization undermines the

trust that supports leadership and impairs the stakeholder community (Elliot &

Willingham, 1980). While researchers have written extensively about leadership and

leaders’ qualities, the area of why a leader or manager behaves in an unethical manner is

underresearched (Feeley, 2006). Community banks are increasingly important for local

economies and their performance is a local economic catalyst (Critchfield et al., 2004).

Management fraud in a bank affects the viability of the bank as a financial intermediary

and as an ongoing business (BCBS, 2004).

The purpose of the quantitative correlation study was to examine the relationship

between the occurrence of management fraud in community banks in the United States

and financial ratios the FDIC uses to monitor the safety and soundness of banks. Earlier

studies by the OCC (1988), USGAO (1994), and the FDIC (1997) indicated there might

be a link between the occurrence of management fraud and financial failure. The study

was an examination of the ability of financial ratios used by the FDIC to predict the

occurrence of management fraud, the dependent variable in the study.

Conclusions

A matched pairs design facilitated the selection of the experimental and control

groups. The management fraud group was the experimental group. The sample of

community banks was drawn from FDIC financial data. A termination or prohibition

order issued by the FDIC was the criterion for the selection of community banks where

management fraud occurred. The total sample size was 266, forming 133 matched pairs

of community banks.
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Three groups of financial ratios (i.e., performance, growth, and capital) were the

independent variables examined for the ability to predict the occurrence of management

fraud, the dependent variable. The independent variables were tested for the ability to

predict the occurrence of management fraud at intervals of 1, 2, and 3 years before the

occurrence of management fraud. In total, 26 financial ratios expressing performance,

growth, and capital characteristics of community banks were examined.

Accountants use financial ratios to detect and prevent management fraud. AICPA

auditing standards board released SAS 99 that outlined an approach to the detection and

prevention of material financial statement fraud that included (a) a culture of honesty and

high ethics, (b) antifraud controls, and (c) oversight (AICPA, 2005). While AICPA

guidelines provide a basis for evaluation, the methodology used to implement the

guidelines might have affected their effectiveness (Kaminski et al., 2004). Previous

researchers found that ratio analysis had a limited ability to detect a fraudulent reporting

firm from a nonfraudulent reporting firm. While the current study did not include the

same set of ratios as used in earlier studies, 16 of the 26 financial ratios were significant

in at least one time interval. Only one variable was not significant in all time intervals. In

all, eight financial ratios were significant in all time intervals. Unlike findings from

earlier studies, 31% of the financial ratios used by the FDIC were significant in multiple

time intervals.

Performance Ratio Model H1

Hypothesis H11 involved performance ratios.

H11: Community banks with poor performance ratios have an increased

occurrence of management fraud in subsequent years.


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The performance ratio model H11 had superior results in predicting the likelihood

of management fraud occurring in all three time intervals. The findings indicate that

financial ratios and performance ratios in particular are highly successful in predicting

conditions that increase the likelihood of management fraud. The alternative Hypothesis

H11(t-2) correctly predicts the likelihood of management fraud in 74% of cases.

Earlier studies have shown mixed results. D’Aveni’s (1989) and Wheelock and

Wilson (2000) concluded that management’s use of financial resources impacted

performance and organizational decline. Many indicators of organizational decline

approximate the indicators used by auditors in their fraud detection analysis.

Apostolou et al. (2001) examined the fraud risk factors that auditors use in

making a determination during an external audit. Apostolou et al. found that auditors

viewed management characteristics and control procedures as more important than

operational and financial characteristics such as financial ratios. Auditors believe

economic characteristics to be the least effective method of evaluating the risk factors of

fraudulent activities.

Growth Ratio Model H2

Hypothesis H21 involved growth ratios.

H21: Community banks with high growth ratios have an increased occurrence of

management fraud in subsequent years.

In two time intervals of the growth ratio model, H21(t-1) and H21(t-3), showed an

increased ability in explaining the variations in the dependent variable than the null

hypothesis. Both H21(t-1) and H21(t-3) showed a lesser degree of explanation than the
135

performance ratio models H11 and H12. The H21(t-2), alternative hypothesis produced poor

model fit and was rejected.

Rapid growth has been previously identified as a risk factor for the occurrence of

management fraud. Rapid asset growth combined with falling capital ratios is an

indicator of concern for developing moral hazard within a banking institution (King et al.,

2005). The current study findings confirm the relationship between growth and

management fraud. The H21(t-1) and H21(t-3) growth ratio models showed better predictive

abilities than the null hypothesis. The lack of model fit for H21(t-2) suggests that more

work is needed to refine the connection between growth and the occurrence of

management fraud.

Capital Ratio Model H3

Hypothesis H31 involved capital ratios.

H31: Community banks with poor capital ratios have an increased occurrence of

management fraud in subsequent years.

In the capital ratio model H31, all three models were significant in the overall

model fit, but all capital ratio models H31 showed only marginal ability to predict a no

fraud community bank outcome. This result is contrary to the concept that measures of

organizational decline are predictive of management fraud.

Cebula (1999), Wheelock and Wilson (2000), and Estrella et al. (2000) used

capital ratios as predictors in failing or declining banking institutions. Weak capital

positions as illustrated by capital ratios are all strong predictors of organizational decline.

In the current study, capital ratios showed only a marginally better ability to predict

management fraud than the null hypothesis.


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Logistic Regression Coefficients

Three independent variables in the performance ratio model H12 were significant

in the three time intervals. The three variables were NTLNLSR net charge-offs to loans,

ASTEMPM assets per employee, and IDLNCORR net loans and leases to core deposits.

NTLNLSR and IDLNCORR both focus on loans, their quality, and how they are

supported. Findings in previous studies have supported the relationship between loans

and management fraud at banks (FDIC, 1997; OCC, 1988; USGAO, 1994).

The significance of ASTEMPM was not expected nor was the negative direction

of the B-value. ASTEMPM was also significant in the growth ratio models H21(t-1) and

H21(t-3). Assets per employee are a measure of efficiency in the use of resources rather

than profitability. As a community bank becomes more efficient, the likelihood of

management fraud decreases. No measure of profitability was significant.

Limitations

Investigations of fraud are limited to discovered occurrences of fraud. The narrow

definition of management fraud in the study was measurable and involved a single

regulator, the FDIC. There are different methods of defining management fraud in other

industry settings that might not be measurable or consistently applied. The focus of the

study was limited to community banks that are small by definition and represent a less

complex business model than other banks. Generalizing the conclusions of the study to

larger more complex financial institutions might not be possible.

Implications

Management fraud in a bank affects the viability of the bank as a financial

intermediary and as an ongoing business and attacks the trust developed with bank
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stakeholders (BCBS, 2004; Elliot & Willingham, 1980). The results of the current study

suggest that performance ratios used by the FDIC in monitoring community banks’ safety

and soundness can be deployed in evaluating the likelihood of management fraud

occurrences. Other methods of measuring financial soundness such as growth and capital

ratios do not appear to evaluate the likelihood of management fraud as effectively or

consistently.

Investors, auditors, and other stakeholders evaluate FDIC-insured community

banks as well as many publicly traded organizations (Altman, 1983; Kaminski et al.,

2004). The evaluation methods include financial ratio analysis (Kaminski et al., 2004).

The ability to use performance ratios in the analytic model of management fraud to

determine whether conditions likely to encourage the occurrence of management fraud

exist provides a tool for leadership in organizations.

Leadership and particularly transformational leadership is a key component in

building trust with the community of stakeholders (Burns, 1978). The focus of the study

was the dysfunction that management fraud brings to community banks and the possible

methods of early detection of its presence. Leadership is concerned with end values.

Burns stated, “Leaders ‘raise’ their followers up through levels of morality” (p. 426).

Management fraud is the antithesis of this concept.

Cressey (1971) stated that certain elements were present when individuals

engaged in management fraud. The elements of pressure, opportunity, and rationalization

create conditions in organizations that increase the likelihood of management fraud. The

financial ratios used in the performance ratio model H11 and H12 show a strong

predictive ability in determining the presence of such conditions. In analyzing the


138

significant variables in H12, a case can be made that the variables represent Cressey’s

conditions.

The variable NTLNLSR net charge-offs to loans represents the percentage of

delinquent loans made by the bank. As the percentage of delinquent loans rises, the

likelihood of management fraud increases. As stated in Table 17, at time interval H12(t-1),

the likelihood of management fraud rises 2.05 fold, in time interval H12(t-2), 3.50 fold, and

in time interval H12(t-3), 1.60 fold.

The loans a bank makes can become delinquent for various reasons including

poor economic conditions. A rising nonpayment rate can also represent inferior lending

practices or controls at the bank. Cressey’s (1971) fraud triangle suggests that inferior

lending practices and controls represented an opportunity to commit management fraud.

The variable IDLNCORR net loans and leases to core deposits represents the

percentage of loans supported by core deposits. The FDIC (2007a) defines core deposits

as local checking, savings, or time deposits that are smaller than $100,000. Core deposits

are more stable deposits, considered less sensitive to interest rate variations, and represent

a less volatile source of funding for a bank. As the percentage of loans supported by core

deposits increases, the likelihood of management fraud increases. As stated in Table 17,

at time interval H12(t-1), the likelihood of management fraud rises 1.02 fold, in time

interval H12(t-2), 1.03 fold, and in time interval H12(t-3), 1.03 fold.

All banks in the United States are required to hold a portion of deposits as a

reserve against losses. The greater the percentage of loans to core deposits, the greater the

reliance on more volatile noncore deposits to meet the reserve requirements (Mishkin,
139

2007). An increasing level of loans supported by core deposits can be caused by different

circumstances including macroeconomic conditions.

Reliance on more volatile deposits represents increased risk taking and can be an

indication of poor decision making. According to hubris theory (Barnes, 2004),

overconfidence in management’s abilities leads to poor decision making and management

indiscretion. Management indiscretion creates opportunities for management fraud.

The significance of variable ASTEMPM assets per employee was not expected.

The negative sign of the B-value indicates an inverse relationship with the occurrence of

management fraud. As the amount of assets per employee increases, the likelihood of

management fraud decreases.

As stated in Table 17, at time interval H12(t-1), the likelihood of management fraud

falls 1.66 (the inverse of .60) fold. In time interval H12(t-2), the likelihood of management

fraud falls 1.92 (the inverse of .52) fold, and in time interval H12(t-3), 1.81 (the inverse of

.55) fold. Assets per employee can represent efficiency. The more efficient the bank’s

operations, the less likely conditions for management fraud will exist.

According to agency theory, excess capital resources lead to management’s

inefficient use of the resources (Meckling & Jensen, 1976). Inefficient use of a

company’s resources leads to management interests diverging from the interests of

shareholders. The same principle applies to human resources. The inefficient use of

human resources, reflected in a lower asset to employee ratio, leads to management

interests diverging from shareholder interests, creating an opportunity for an increase in

the conditions that encourage management fraud.


140

Measuring the relative presence of conditions likely to encourage management

fraud would also measure management’s attitude to those conditions. Sutherland (1973)

proposed that white-collar crime was a learned behavior prompted by the absence of

individuals who reject it. The acceptance of conditions that increase the likelihood of

management fraud occurs over time and spreads in an organization (Baker & Faulkner,

2003).

The Analytic Model of Management Fraud in Community Banks

In the analytic model of management fraud in community banks, the financial

ratios of performance, growth, and capital depict the data found in financial statements

that determine the comparative condition of community banks. Financial statements are a

documentation of management’s actions and are numerical interpretations of the financial

condition of the bank. Financial statements are a lens providing transparency into the

operations of community banks and management’s behavior.

The findings of the current study indicate the analytic model of management fraud

in community banks can be refined. The logistical regression model instrument provides

predictive values based upon the performance ratios used by the FDIC. The performance

ratios might identify the characteristics of management fraud as expressed by Cressey

(1971).

Viewed over time, the predictive values from the model indicate the degree of

diffusion of the characteristics of management fraud in a community bank. The revised

analytic model of management fraud in community banks is depicted in Figure 3. The

revised model provides theoretical foundations for the use of financial ratios as indicators

of management fraud at community banks.


141

Figure 3. Revised Analytic Model of Management Fraud in Community Banks.

Recommendations

The recommendations for future action are comprised of two parts. The first

section includes recommendations for leaders, managers, and stakeholders of

organizations and how to apply the lessons learned from the study to organizations. The

second section discusses additional areas of research.

Recommendations for Leaders

Recognizing the conditions that can give rise to an occurrence of management

fraud allows leaders, managers, and stakeholders to consider preventive and corrective

actions to maintain the necessary levels of trust between stakeholders. Leaders should

review the implications of measuring the conditions that make fraud more likely. Leaders

should consider methods of advancing the practical application of the analytical model of

management fraud within their organization. Leaders and stakeholders can use the model
142

to test projected changes in the organization against increasing the likelihood of

management fraud.

Recommendations for Research

The analytic model of management fraud provides a methodology for examining

the linkage between management fraud and financial analysis. Exploring growth and

capital ratios beyond ratios used in financial decline or by the FDIC is an additional area

of potential research. Other measures of growth and capital such as long- and short-term

growth rates and different capital formations might provide different results.

Additional areas of study include using different populations of different sizes and

industries. The study was limited to a narrow subset of financial institutions in a highly

regulated industry. Expansion of the concepts in the analytic model of management fraud

to different types of financial institutions such as mortgage bankers, credit unions, or

stockbrokers should be considered.

Replication of the study with different definitions of management fraud is an

additional area of potential research. Different standards for defining fraudulent activities

could produce supporting or differing results. Customer complaints of fraudulent actions

or deceptive practices or legal actions alleging fraud could form the basis for additional

studies. Expanding the timeframe to include a larger sample size or additional time

intervals would add to the body of research.

Summary and Conclusion

The focus of the quantitative correlational study was the relationship between the

occurrence of management fraud in community banks in the United States and financial

ratios the FDIC uses to monitor the safety and soundness of banks. The theoretical
143

framework reflected the concept that financial statements provide a lens to view the

actions of management. Previous researchers suggested that management fraud occurred

when certain conditions were present. In Figure 3, the foundational concepts of Cressey

(1971) and Sutherland (1973) are incorporated into the analytic model of management

fraud in community banks.

The logistical regression model tested three groups of financial ratios (i.e.,

performance, growth, and capital). The performance ratio logistical regression model

provided strong and consistent predictive results over multiple timeframes. The

performance ratio logistical regression model provided strong and consistent predictive

results over multiple timeframes. The results of the performance ratio logistical

regression model (Appendices G, I, and J) support the conceptual framework of the study

as illustrated in the revised analytic model of management fraud (Figure 3). The revised

analytic model of management fraud in community banks provides leaders and

stakeholders a tool for the detection and prevention of management fraud.


144

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157

APPENDIX A: INFORMED CONSENT


158

All the data that will be used in the study is in the public domain and as such does

not require obtaining permission or informed consent. The financial data will be drawn

from a publicly available database maintained by the FDIC on their website,

http://www2.fdic.gov/sd/index.asp. The data concerning prohibition or termination orders

issued by the FDIC will be drawn from a publicly available database maintained by the

FDIC in another section of their website found at

http://www.fdic.gov/bank/individual/enforcement/index.html.

Although the raw data are available from a public domain, these data will be

reorganized, coded, and analyzed to test the Hypotheses. During and after the data

organization and analysis process, the coded data will be stored in a locked cabinet and

will be accessible only by the researcher. All data will be secured for a period of three

years and then destroyed by shredding.


159

APPENDIX B: SAMPLE OF FDIC ENFORCEMENT ORDER


160
161

Note. From Federal Deposit Insurance Corporation. (2007b). FDIC Enforcement

Decisions and Orders. Retrieved March 17, 2007, from

http://www.fdic.gov/bank/individual/enforcement/index.html
162

APPENDIX C: SAMPLE OF A COMMUNITY BANK FDIC STATISTICAL

DOWNLOAD
163
164

Note. From Federal Deposit Insurance Corporation. (2007a). Statistics on Depository

Institutions. Retrieved March 17, 2007, from http://www2.fdic.gov/sdi/main.asp


165

APPENDIX D: DESCRIPTIVE STATISTICS FOR THE PERFORMANCE RATIO

MODELS
166

Table D1

Descriptive Statistics for the Performance Ratio Model H1(t-1)

Variables Fraud N M SD SE

INTINCY 0 133 7.7800 .99619 .08638

1 133 8.1691 1.17437 .10183

INTEXPY 0 133 3.4070 .84697 .07344

1 133 3.6405 .85508 .07415

NIMY 0 133 4.3730 1.02565 .08894

1 133 4.5286 1.09462 .09492

NONIIY 0 133 .7350 .54127 .04693

1 133 1.1588 1.09462 .09492

NONIXY 0 133 3.3604 1.26845 .10999

1 133 4.1974 2.10202 .18227

NOIJY 0 133 1.0366 .58522 .05074

1 133 .2804 1.75382 .15208

ROA 0 133 1.0488 .58485 .05071

1 133 .3105 1.74843 .15161

ROE 0 133 10.4812 6.71079 .58190

1 133 2.4111 25.38039 2.20076

ROEINJR 0 133 5.9655 6.69347 .58040

1 133 -1.1311 24.46328 2.12124

NTLNLSR 0 132 .2350 .46639 .04059

1 133 1.2066 2.34259 .20313


167

Table D1 (continued).

Descriptive Statistics for the Performance Ratio Model H1(t-1)

Fraud N M SD SE

ELNANTR 0 123 101.6117 2775.83382 250.28851

1 129 152.6480 620.06099 54.59333

EEFFR 0 133 65.2158 15.72434 1.36347

1 133 72.5455 20.21229 1.75263

ASTEMPM 0 132 2.7948 1.11618 .09715

1 133 2.3088 .79737 .06914

IDDIVNIR 0 133 38.5041 58.03526 5.03230

1 132 30.9671 86.15740 7.49904

LNATRESR 0 132 1.5077 .69601 .06058

1 132 2.0833 1.58865 .13827

LNRESNCR 0 119 1399.1252 5782.77807 530.10640

1 130 330.9966 830.09902 72.80450

NPERFV 0 133 .8234 1.44494 .12529

1 133 1.8185 2.21017 .19165

NCLNLSR 0 132 1.1723 1.93851 .16873

1 132 2.2925 2.77817 .24181

LNLSDEPR 0 133 68.2518 19.82720 1.71924

1 133 71.6048 15.40991 1.33621

IDLNCORR 0 132 78.8706 23.64992 2.05846

1 133 84.5499 22.71609 1.96974


168

Table D2

Descriptive Statistics for the Performance Ratio Model H1(t-2)

Variable Fraud N M SD SE

INTINCY .00 133 7.9217 .88570 .07680

1.00 133 8.3824 1.26767 .10992

INTEXPY .00 133 3.4784 .72887 .06320

1.00 133 3.7170 .82812 .07181

NIMY .00 133 4.4432 .99912 .08663

1.00 133 4.6654 1.23149 .10678

NONIIY .00 133 .7115 .57689 .05002

1.00 133 1.1247 1.04358 .09049

NONIXY .00 133 3.3915 1.26026 .10928

1.00 133 4.1339 1.76864 .15336

NOIJY .00 133 1.0530 .60920 .05282

1.00 133 .6345 1.09699 .09512

ROA .00 133 1.0514 .63396 .05497

1.00 133 .6501 1.09122 .09462

ROE .00 133 10.4468 6.43693 .55815

1.00 133 7.1939 13.48288 1.16911

ROEINJR .00 133 5.8308 6.25326 .54223

1.00 133 3.3434 12.88032 1.11687

NTLNLSR .00 133 .2034 .38978 .03380

1.00 133 .6795 1.10292 .09563


169

Table D2 (continued).

Descriptive Statistics for the Performance Ratio Model H1(t-2)

Variable Fraud N M SD SE

ELNANTR .00 124 183.9340 1230.51025 110.50308

1.00 129 113.4977 586.59234 51.64658

EEFFR .00 133 65.5902 16.74255 1.45176

1.00 133 71.2436 21.42237 1.85755

ASTEMPM .00 132 2.6625 1.03535 .09012

1.00 133 2.2658 .84960 .07367

IDDIVNIR .00 133 42.7055 91.23956 7.91147

1.00 133 17.5860 93.88622 8.14097

LNATRESR .00 132 1.5784 .81321 .07078

1.00 133 1.8771 1.40733 .12203

LNRESNCR .00 119 606.7795 1399.98383 128.33631

1.00 128 278.8151 573.30018 50.67306

NPERFV .00 133 .8724 1.51921 .13173

1.00 133 1.7006 2.05402 .17811

NCLNLSR .00 132 1.2773 2.15173 .18728

1.00 133 1.9918 2.29313 .19884

LNLSDEPR .00 133 66.5784 19.02780 1.64992

1.00 133 72.4506 16.02027 1.38913

IDLNCORR .00 132 75.6765 21.51919 1.87301

1.00 133 85.4204 23.38424 2.02767


170

Table D3

Descriptive Statistics for the Performance Ratio Model H1(t-3)

Variables Fraud N M SD SE

INTINCY .00 133 7.8994 1.09635 .09507

1.00 133 8.4320 1.49748 .12985

INTEXPY .00 133 3.4572 .76308 .06617

1.00 133 3.6741 .80519 .06982

NIMY .00 133 4.4423 1.04558 .09066

1.00 133 4.7579 1.39726 .12116

NONIIY .00 133 .7536 .58306 .05056

1.00 133 1.1458 1.32219 .11465

NONIXY .00 133 3.4530 1.29397 .11220

1.00 133 4.2744 2.35744 .20442

NOIJY .00 133 .9296 .77787 .06745

1.00 133 .6828 1.61358 .13991

ROA .00 133 .9467 .80808 .07007

1.00 133 .7134 1.61877 .14037

ROE .00 133 9.6617 8.62970 .74829

1.00 133 8.0923 17.39929 1.50871

ROEINJR .00 133 5.2955 8.31588 .72108

1.00 133 3.7578 15.91687 1.38017

NTLNLSR .00 133 .2872 .66246 .05744

1.00 133 .5567 .86937 .07538


171

Table D3 (continued).

Descriptive Statistics for the Performance Ratio Model H1(t-3)

Variables Fraud N M SD SE

ELNANTR .00 122 133.6367 734.16729 66.46838

1.00 125 344.0816 1101.60883 98.53089

EEFFR .00 132 65.8406 14.97378 1.30330

1.00 133 73.1473 40.65047 3.52484

ASTEMPM .00 132 2.5876 1.02503 .08922

1.00 133 2.2145 .90227 .07824

IDDIVNIR .00 132 35.4912 45.32556 3.94508

1.00 133 33.2474 39.68518 3.44114

LNATRESR .00 133 1.5963 .85909 .07449

1.00 133 1.7100 1.19688 .10378

LNRESNCR .00 125 509.3616 1015.18703 90.80109

1.00 128 348.1028 1072.35866 94.78401

NPERFV .00 133 .9889 1.46499 .12703

1.00 133 1.6866 2.61748 .22696

NCLNLSR .00 133 1.3213 1.95070 .16915

1.00 133 2.0780 2.92806 .25390

LNLSDEPR .00 133 68.4362 34.08112 2.95521

1.00 133 71.8499 15.75056 1.36575

IDLNCORR .00 133 325.6791 2899.70365 251.43619

1.00 133 83.3474 21.83808 1.89360


172

Table D4

Descriptive Statistics for Growth Ratio Model H2(t-1)

Variables Fraud N M SD SE

ROLLPS5TA .00 133 .7368 .20206 .01752

1.00 133 .7680 .15439 .01339

ROVLTA .00 133 .1178 .06977 .00605

1.00 133 .1335 .08999 .00780

ASTEMPM .00 132 2.7901 1.11633 .09716

1.00 133 2.3088 .79737 .06914

EQV .00 133 11.3631 8.36294 .72516

1.00 133 9.2558 2.99035 .25930

Table D5

Descriptive Statistics for Growth Ratio Model H2(t-2)

Variables Fraud N M SD SE

ROLLPS5TA .00 133 .7260 .20656 .01791

1.00 133 .7709 .15389 .01334

ROVLTA .00 133 .1032 .05992 .00520

1.00 133 .1329 .08710 .00755

ASTEMPM .00 132 2.6625 1.03535 .09012

1.00 133 2.2658 .84960 .07367

EQV .00 133 11.1361 8.23901 .71441

1.00 133 9.0294 2.52293 .21877


173

Table D6

Descriptive Statistics for Growth Ratio Model H2(t-3)

Variables Fraud N M SD SE

ROLLPS5TA .00 133 .7130 .20508 .01778

1.00 133 .7540 .14990 .01300

ROVLTA .00 133 .1012 .06326 .00549

1.00 133 .1243 .08288 .00719

ASTEMPM .00 132 2.5654 1.03775 .09032

1.00 133 2.2145 .90227 .07824

EQV .00 133 11.2046 8.08446 .70101

1.00 133 9.1882 2.79623 .24246

Table D7

Descriptive Statistics for Capital Ratio Model H3(t-1)

Variables Fraud N M SD SE

EQV .00 133 11.3631 8.36294 .72516

1.00 133 9.2558 2.99035 .25930

RBC1AAJ .00 133 11.2182 8.42800 .73080

1.00 133 8.9373 2.67958 .23235

RBC1RWAJ .00 133 18.6775 12.12609 1.05147

1.00 133 13.9623 5.49452 .47644

RBCRWAJ .00 133 19.8148 12.10434 1.04958

1.00 133 15.1367 5.50705 .47752


174

Table D8

Descriptive Statistics for Capital Ratio Model H3(t-2)

Variables Fraud N M SD SE

EQV .00 133 11.1361 8.23901 .71441

1.00 133 9.0294 2.52293 .21877

RBC1AAJ .00 133 11.1956 8.29603 .71936

1.00 133 8.9495 2.50824 .21749

RBC1RWAJ .00 133 19.0864 11.90364 1.03218

1.00 133 13.9666 5.35228 .46410

RBCRWAJ .00 133 20.2338 11.87919 1.03006

1.00 133 15.1164 5.36831 .46549

Table D9

Descriptive Statistics for Capital Ratio Model H3(t-3)

Variables Fraud N M SD SE

EQV .00 133 11.2046 8.08446 .70101

1.00 133 9.1882 2.79623 .24246

RBC1AAJ .00 133 11.2448 8.13139 .70508

1.00 133 9.0538 2.88114 .24983

RBC1RWAJ .00 133 19.4069 11.81627 1.02460

1.00 133 14.4543 6.62372 .57435

RBCRWAJ .00 133 20.5482 11.82952 1.02575

1.00 133 15.5676 6.64650 .57632


175

APPENDIX E: T-TESTS FOR THE PERFORMANCE RATIO MODEL


176

Table E1

T-Tests for the Performance Ratio Model H1(t-1)

p 95% C.I.

F Sig. t (2-tailed) Upper Lower

INTINCY 1.196 .275 -2.914 .004 -.65206 -.12621

INTEXPY .382 .537 -2.238 .026 -.43900 -.02803

NIMY .122 .727 -1.196 .233 -.41173 .10049

NONIIY 17.767 .000 -4.002 .000 -.63226 -.21528

NONIXY 9.760 .002 -3.932 .000 -1.25613 -.41780

NOIJY 27.948 .000 4.717 .000 .44049 1.07182

ROA 26.779 .000 4.619 .000 .42358 1.05312

ROE 19.940 .000 3.545 .000 3.58798 12.55236

ROEINJR 19.693 .000 3.227 .001 2.76633 11.42676

NTLNLSR 41.699 .000 -4.674 .000 -1.38095 -.56235

ELNANTR 4.705 .031 -.204 .839 -544.77 442.69697

EEFFR 5.981 .015 -3.301 .001 -11.70194 -2.95753

ASTEMPM 10.348 .001 4.080 .000 .25144 .72045

IDDIVNIR .785 .376 .836 .404 -10.21997 25.29411

LNATRESR 26.639 .000 -3.813 .000 -.87282 -.27831

LNRESNCR 13.347 .000 2.083 .038 58.17324 2078.08384

NPERFV 20.703 .000 -4.346 .000 -1.44601 -.54434


177

Table E1 (continued).

T-Tests for the Performance Ratio Model H1(t-1)

p 95% C.I.

F Sig. t (2-tailed) Upper Lower

NCLNLSR 17.666 .000 -3.799 .000 -1.70079 -.53961

LNLSDEPR 5.239 .023 -1.540 .125 -7.64033 .93437

IDLNCORR .057 .812 -1.994 .047 -11.28823 -.07022


178

Table E2

T-Tests for the Performance Ratio Model H1(t-2)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

INTINCY 2.001 .158 -3.436 .001 -.72479 -.19674

INTEXPY 3.295 .071 -2.494 .013 -.42694 -.05024

NIMY .453 .502 -1.616 .107 -.49292 .04858

NONIIY 15.191 .000 -3.997 .000 -.61686 -.20969

NONIXY 8.054 .005 -3.942 .000 -1.11312 -.37156

NOIJY 14.785 .000 3.846 .000 .20420 .63267

ROA 13.720 .000 3.667 .000 .18584 .61678

ROE 16.649 .000 2.511 .013 .70204 5.80375

ROEINJR 18.605 .000 2.003 .046 .04277 4.93189

NTLNLSR 21.647 .000 -4.693 .000 -.67575 -.27631

ELNANTR 2.245 .135 .585 .559 -166.80893 307.68151

EEFFR 2.221 .137 -2.398 .017 -10.29546 -1.01140

ASTEMPM 3.471 .064 3.411 .001 .16767 .62571

IDDIVNIR .023 .879 2.213 .028 2.76754 47.47131

LNATRESR 9.268 .003 -2.113 .036 -.57699 -.02039

LNRESNCR 12.633 .000 2.440 .015 63.18766 592.74120

NPERFV 8.434 .004 -3.738 .000 -1.26432 -.39194


179

Table E2 (continued).

T-Tests for the Performance Ratio Model H1(t-2)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

NCLNLSR 2.997 .085 -2.615 .009 -1.25250 -.17656

LNLSDEPR 1.473 .226 -2.723 .007 -10.11892 -1.62535

IDLNCORR 1.621 .204 -3.529 .000 -15.18084 -4.30699


180

Table E3

T-Tests for the Performance Ratio Model H1(t-3)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

INTINCY 2.059 .152 -3.310 .001 -.84947 -.21573

INTEXPY 2.173 .142 -2.255 .025 -.40634 -.02754

NIMY .408 .523 -2.086 .038 -.61361 -.01770

NONIIY 10.971 .001 -3.130 .002 -.63895 -.14552

NONIXY 9.858 .002 -3.523 .001 -1.28053 -.36226

NOIJY 5.676 .018 1.589 .113 -.05900 .55266

ROA 5.174 .024 1.487 .138 -.07555 .54225

ROE 9.283 .003 .932 .352 -1.74661 4.88529

ROEINJR 5.123 .024 .988 .324 -1.52834 4.60381

NTLNLSR 5.359 .021 -2.844 .005 -.45615 -.08293

ELNANTR .654 .419 -1.762 .079 -445.65329 24.76340

EEFFR 5.559 .019 -1.939 .054 -14.72772 .11448

ASTEMPM 1.376 .242 3.146 .002 .13954 .60662

IDDIVNIR .001 .971 .429 .668 -8.05882 12.54653

LNATRESR 4.249 .040 -.889 .375 -.36517 .13791

LNRESNCR 1.694 .194 1.228 .221 -97.41845 419.93612

NPERFV 6.225 .013 -2.682 .008 -1.20975 -.18550


181

Table E3 (continued).

T-Tests for the Performance Ratio Model H1(t-3)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

NCLNLSR 6.100 .014 -2.480 .014 -1.35740 -.15600

LNLSDEPR 2.206 .139 -1.049 .295 -9.82382 2.99642

IDLNCORR 3.793 .053 .964 .336 -252.75780 737.42124

Table E4

Description of Variables in Growth Ratio Model H2(t-1)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

ROLLPS5TA 7.387 .007 -1.417 .158 -.07466 .01217

ROVLTA 5.436 .020 -1.595 .112 -.03519 .00370

ASTEMPM 10.208 .002 4.041 .000 .24674 .71579

EQV 4.498 .035 2.736 .007 .59089 3.62362


182

Table E5

Description of Variables in Growth Ratio Model H2(t-2)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

ROLLPS5TA 7.117 .008 -2.013 .045 -.08894 -.00099

ROVLTA 13.769 .000 -3.241 .001 -.04776 -.01166

ROVLTA 3.471 .064 3.411 .001 .16767 .62571

EQV 4.639 .032 2.820 .005 .63563 3.57792

Table E6

Description of Variables in Growth Ratio Model H2(t-3)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

ROLLPS5TA 10.148 .002 -1.861 .064 -.08436 .00238

ROVLTA 8.646 .004 -2.558 .011 -.04092 -.00532

ROVLTA 1.756 .186 2.939 .004 .11579 .58613

EQV 4.936 .027 2.718 .007 .55588 3.47691


183

Table E7

Description of Variables in Capital Ratio Model H3(t-1)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

EQV 4.498 .035 2.736 .007 .59089 3.62362

RBC1AAJ 5.629 .018 2.974 .003 .77096 3.79079

RBC1RWAJ 12.701 .000 4.085 .000 2.44227 6.98815

RBCRWAJ 12.762 .000 4.057 .000 2.40766 6.94855

Table E8

Description of Variables in Capital Ratio Model H3(t-2)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

EQV 4.639 .032 2.820 .005 .63563 3.57792

RBC1AAJ 5.277 .022 2.989 .003 .76636 3.72582

RBC1RWAJ 14.540 .000 4.524 .000 2.89143 7.34810

RBCRWAJ 14.984 .000 4.527 .000 2.89182 7.34313


184

Table E9

Description of Variables in Capital Ratio Model H3(t-3)

p 95% C.I.

Variables F Sig. t (2-tailed) Upper Lower

EQV 4.936 .027 2.718 .007 .55588 3.47691

RBC1AAJ 5.641 .018 2.929 .004 .71818 3.66392

RBC1RWAJ 13.315 .000 4.216 .000 2.63987 7.26542

RBCRWAJ 13.728 .000 4.233 .000 2.66397 7.29727


185

APPENDIX F: HISTOGRAMS
186

Histograms for Performance Ratio Model Variables at H1(t-1)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEM PM ASTEM PM

Figure F1. Histogram for ASTEMPM at H1(t-1)

0.00 1.00
40

30
Count

20

10

40.00 80.00 120.00 160.00 40.00 80.00 120.00 160.00


EEFR EEFR

Figure F2. Histogram for EEFR at H1(t-1)


187

0.00 1.00

100

75
Count

50

25

0
-20000.00 -10000.00 0.00 10000.00 -20000.00 -10000.00 0.00 10000.00
ELNANTR ELNANTR

Figure F3. Histogram for ELNANTR at H1(t-1)

0.00 1.00

75

50
Count

25

0
0.00 250.00 500.00 750.00 0.00 250.00 500.00 750.00
IDDIVNIR IDDIVNIR

Figure F4. Histogram for IDDIVNIR at H1(t-1)


188

0.00 1.00

20

15
Count

10

0
0.00 50.00 100.00 150.000.00 50.00 100.00 150.00
IDINCORR IDINCORR

Figure F5. Histogram for IDINCORR at H1(t-1)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 1.00 2.00 3.00 4.00 5.00
INTEXPY INTEXPY

Figure F6. Histogram for INTEXPY at H1(t-1)


189

0.00 1.00
30

20
Count

10

0
4.00 6.00 8.00 10.00 12.00 4.00 6.00 8.00 10.00 12.00
INTINCY INTINCY

Figure F7. Histogram for INTINCY at H1(t-1)

0.00 1.00

30
Count

20

10

0
2.00 4.00 6.00 8.00 2.00 4.00 6.00 8.00
LNATESR LNATESR

Figure F8. Histogram for LNATESR at H1(t-1)


190

0.00 1.00
30

Count 20

10

0
25.00 50.00 75.00 100.00 125.00 25.00 50.00 75.00 100.00 125.00
LNLSDEPR LNLSDEPR

Figure F9. Histogram for LNATESR at H1(t-1)

0.00 1.00
125

100
Count

75

50

25

10000.00 30000.00 10000.00 30000.00


20000.00 40000.00 20000.00 40000.00
LNRESNCR LNRESNCR

Figure F10. Histogram for LNRESNCR at H1(t-1)


191

0.00 1.00
75

50
Count

25

0
0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00
NCLNLSR NCLNLSR

Figure F11. Histogram for NCLNLSR at H1(t-1)

0.00 1.00

20

15
Count

10

0
2.00 4.00 6.00 8.00 2.00 4.00 6.00 8.00
NIMY NIMY

Figure F12. Histogram for NIMY at H1(t-1)


192

0.00 1.00

50

40
Count

30

20

10

-10.00 -5.00 0.00 -10.00 -5.00 0.00


NOIJY NOIJY

Figure F13. Histogram for NOIJY at H1(t-1)

0.00 1.00
40

30
Count

20

10

0.00 2.00 4.00 6.00 0.00 2.00 4.00 6.00


NONIIY NONIIY

Figure F14. Histogram for NONIIY at H1(t-1)


193

0.00 1.00
40

30
Count

20

10

4.00 8.00 12.00 16.00 4.00 8.00 12.00 16.00


NONIXY NONIXY

Figure F15. Histogram for NONIXY at H1(t-1)

0.00 1.00
75

50
Count

25

0
0.00 4.00 8.00 12.00 0.00 4.00 8.00 12.00
NPERFV NPERFV

Figure F16. Histogram for NPERFV at H1(t-1)


194

0.00 1.00

Count 60

40

20

0
0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00
NTLNLSR NTLNLSR

Figure F17. Histogram for NTLNLSR at H1(t-1)

0.00 1.00

50

40
Count

30

20

10

-10.00 -5.00 0.00 -10.00 -5.00 0.00


ROA ROA

Figure F18. Histogram for ROA at H1(t-1)


195

0.00 1.00

Count 60

40

20

0
-150.00 -100.00 -50.00 0.00 -150.00 -100.00 -50.00 0.00
ROE ROE

Figure F19. Histogram for ROE at H1(t-1)

0.00 1.00

75
Count

50

25

0
-150.00 -100.00 -50.00 0.00 -150.00 -100.00 -50.00 0.00
ROEINJR ROEINJR

Figure F20. Histogram for ROEINJR at H1(t-1)


196

Histograms for Performance Ratio Model Variables at H1(t-2)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEMPM ASTEMPM

Figure F21. Histogram for ASTEMPM at H1(t-2)

0.00 1.00
40

30
Count

20

10

50.00 100.00 150.00 200.00 50.00 100.00 150.00 200.00


EEFFR EEFFR

Figure F22. Histogram for EEFFR at H1(t-2)


197

0.00 1.00

100

75
Count

50

25

0
0.00 4000.00 8000.00 12000.00 0.00 4000.00 8000.00 12000.00
ELNANTR ELNANTR

Figure F23. Histogram for ELNANTR at H1(t-2)

0.00 1.00

75

50
Count

25

0
-400.00 0.00 400.00 800.00 -400.00 0.00 400.00 800.00
IDDIVNIR IDDIVNIR

Figure F24. Histogram for IDDIVNIR at H1(t-2)


198

0.00 1.00

20

15
Count

10

0
25.00 50.00 75.00 100.00125.00 25.00 50.00 75.00 100.00125.00
IDLNCORR IDLNCORR

Figure F25. Histogram for IDLNCORR at H1(t-2)

0.00 1.00
25

20

15
Count

10

1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
INTEXPY INTEXPY

Figure F26. Histogram for INTEXPY at H1(t-2)


199

0.00 1.00

40

30
Count

20

10

4.00 8.00 12.00 16.00 4.00 8.00 12.00 16.00


INTINCY INTINCY

Figure F27. Histogram for INTINCY at H1(t-2)

0.00 1.00

40

30
Count

20

10

2.00 4.00 6.00 8.00 10.00 2.00 4.00 6.00 8.00 10.00
LNATRESR LNATRESR

Figure F28. Histogram for LNATRESR at H1(t-2)


200

0.00 1.00

20

15
Count

10

0
0.00 25.00 50.00 75.00 100.00 0.00 25.00 50.00 75.00 100.00
LNLSDEPR LNLSDEPR

Figure F29. Histogram for LNLSDEPR at H1(t-2)

0.00 1.00

100

75
Count

50

25

0
2000.00 4000.00 6000.00 8000.00 2000.00 4000.00 6000.00 8000.00
LNRESNCR LNRESNCR

Figure F30. Histogram for LNRESNCR at H1(t-2)


201

0.00 1.00

60
Count

40

20

0
0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00
NCLNLSR NCLNLSR

Figure F31. Histogram for NCLNLSR at H1(t-2)

0.00 1.00
30

20
Count

10

0
2.50 5.00 7.50 10.00 12.50 2.50 5.00 7.50 10.00 12.50
NIMY NIMY

Figure F32. Histogram for NIMY at H1(t-2)


202

0.00 1.00
40

Count 30

20

10

-4.00 -2.00 0.00 2.00 -4.00 -2.00 0.00 2.00


NOIJY NOIJY

Figure F33. Histogram for NOIJY at H1(t-2)

0.00 1.00

40

30
Count

20

10

0.00 2.00 4.00 6.00 0.00 2.00 4.00 6.00


NONIIY NONIIY

Figure F34. Histogram for NONIIY at H1(t-2)


203

0.00 1.00
30

20
Count

10

0
2.00 4.00 6.00 8.00 10.00 2.00 4.00 6.00 8.00 10.00
NONIXY NONIXY

Figure F35. Histogram for NONIXY at H1(t-2)

0.00 1.00
75

50
Count

25

0
0.00 4.00 8.00 12.00 0.00 4.00 8.00 12.00
NPERFV NPERFV

Figure F36. Histogram for NPERFV at H1(t-2)


204

0.00 1.00

60
Count

40

20

0
0.00 2.00 4.00 6.00 0.00 2.00 4.00 6.00
NTLNLSR NTLNLSR

Figure F37. Histogram for NTLNLSR at H1(t-2)

0.00 1.00

30
Count

20

10

0
-4.00 -2.00 0.00 2.00 -4.00 -2.00 0.00 2.00
ROA ROA

Figure F38. Histogram for ROA at H1(t-2)


205

0.00 1.00
40

30
Count

20

10

-50.00 -25.00 0.00 25.00 -50.00 -25.00 0.00 25.00


ROE ROE

Figure F39. Histogram for ROE at H1(t-2)

0.00 1.00

40

30
Count

20

10

-50.00 -25.00 0.00 25.00 -50.00 -25.00 0.00 25.00


ROEINJR ROEINJR

Figure F40. Histogram for ROEINJR at H1(t-2)


206

Histograms for Performance Ratio Model Variables at H1(t-3)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEMPM ASTEMPM

Figure F41. Histogram for ASTEMPM at H1(t-3)

0.00 1.00
75

50
Count

25

0
100.00 200.00 300.00 400.00 100.00 200.00 300.00 400.00
EEFFR EEFFR

Figure F42. Histogram for EEFFR at H1(t-3)


207

0.00 1.00
75

50
Count

25

0
-5000.00 0.00 5000.00 10000.00
-5000.00 0.00 5000.00 10000.00
ELNANTR ELNANTR

Figure F43. Histogram for ELNANTR at H1(t-3)

0.00 1.00

40

30
Count

20

10

0.00 100.00 200.00 300.00 0.00 100.00 200.00 300.00


IDDIVNIR IDDIVNIR

Figure F44. Histogram for IDDIVNIR at H1(t-3)


208

0.00 1.00
125

100
Count

75

50

25

10000.00 20000.00 30000.00 10000.00 20000.00 30000.00


IDLNCORR IDLNCORR

Figure F45. Histogram for IDLNCORR at H1(t-3)

0.00 1.00
25

20

15
Count

10

1.00 2.00 3.00 4.00 5.00 1.00 2.00 3.00 4.00 5.00
INTEXPY INTEXPY

Figure F46. Histogram for INTEXPY at H1(t-3)


209

0.00 1.00

50

40
Count

30

20

10

0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00


INTINCY INTINCY

Figure F47. Histogram for INTINCY at H1(t-3)

0.00 1.00
30

20
Count

10

0
0.00 2.00 4.00 6.00 0.00 2.00 4.00 6.00
LNATRESR LNATRESR

Figure F48. Histogram for LNATRESR at H1(t-3)


210

0.00 1.00

50

40
Count

30

20

10

100.00 200.00 300.00 100.00 200.00 300.00


LNLSDEPR LNLSDEPR

Figure F49. Histogram for LNLSDEPR at H1(t-3)

0.00 1.00

100

75
Count

50

25

0
2500.00 5000.00 7500.00 10000.00 2500.00 5000.00 7500.00 10000.00
LNRESNCR LNRESNCR

Figure F50. Histogram for LNRESNCR at H1(t-3)


211

0.00 1.00

60

40
Count

20

0
0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00
NCLNLSR NCLNLSR

Figure F51. Histogram for NCLNLSR at H1(t-3)

0.00 1.00
40

30
Count

20

10

0.00 5.00 10.00 15.00


0.00 5.00 10.00 15.00
NIMY NIMY

Figure F52. Histogram for NIMY at H1(t-3)


212

0.00 1.00
75

50
Count

25

0
-12.00 -8.00 -4.00 0.00 -12.00 -8.00 -4.00 0.00
NOIJY NOIJY

Figure F53. Histogram for NOIJY at H1(t-3)

0.00 1.00

40

30
Count

20

10

2.00 4.00 6.00 8.00 2.00 4.00 6.00 8.00


NONIIY NONIIY

Figure F54. Histogram for NONIIY at H1(t-3)


213

0.00 1.00

40

30
Count

20

10

0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00


NONIXY NONIXY

Figure F55. Histogram for NONIXY at H1(t-3)

0.00 1.00

75

50
Count

25

0
0.00 5.00 10.00 15.00 0.00 5.00 10.00 15.00
NPERFV NPERFV

Figure F56. Histogram for NPERFV at H1(t-3)


214

0.00 1.00
75

50
Count

25

0
0.00 2.00 4.00 0.00 2.00 4.00
NTLNLSR NTLNLSR

Figure F57. Histogram for NTLNLSR at H1(t-3)

0.00 1.00
75

50
Count

25

0
-12.00 -8.00 -4.00 0.00 -12.00 -8.00 -4.00 0.00
ROA ROA

Figure F58. Histogram for ROA at H1(t-3)


215

0.00 1.00
60

40
Count

20

0
-80.00 -40.00 0.00 40.00 -80.00 -40.00 0.00 40.00
ROE ROE

Figure F59. Histogram for ROE at H1(t-3)

0.00 1.00

50

40
Count

30

20

10

-75.00 -50.00 -25.00 0.00 -75.00 -50.00 -25.00 0.00


ROEINJR ROEINJR

Figure F60. Histogram for ROEINJR at H1(t-3)


216

Histograms for Growth Ratio Model Variables at H2(t-1)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEMPM ASTEMPM

Figure F61. Histogram for ASTEMPM at H2(t-1)

0.00 1.00

60
Count

40

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F62. Histogram for EQV at H2(t-1)


217

0.00 1.00

20

15
Count

10

0
0.00 0.50 1.00 0.00 0.50 1.00
ROLLPS5TA ROLLPS5TA

Figure F63. Histogram for ROLLPS5TA at H2(t-1)

0.00 1.00
25

20
Count

15

10

0.10 0.20 0.30 0.40 0.50 0.10 0.20 0.30 0.40 0.50
ROVLTA ROVLTA

Figure F64. Histogram for ROVLTA at H2(t-1)


218

Histograms for Growth Ratio Model Variables at H2(t-2)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEMPM ASTEMPM

Figure F65. Histogram for ASTEMPM at H2(t-2)

0.00 1.00

60
Count

40

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F66. Histogram for EQV at H2(t-2)


219

0.00 1.00
30

20
Count

10

0
0.00 0.50 1.00 0.00 0.50 1.00
ROLLPS5TA ROLLPS5TA

Figure F67. Histogram for ROLLPS5TA at H2(t-2)

0.00 1.00

20

15
Count

10

0
0.00 0.10 0.20 0.30 0.40 0.00 0.10 0.20 0.30 0.40
ROVLTA ROVLTA

Figure F68. Histogram for ROVLTA at H2(t-2)


220

Histograms for Growth Ratio Model Variables at H2(t-3)

0.00 1.00

20

15
Count

10

0
1.00 2.00 3.00 4.00 5.00 6.00 1.00 2.00 3.00 4.00 5.00 6.00
ASTEMPM ASTEMPM

Figure F69. Histogram for ASTEMPM at H2(t-3)

0.00 1.00
75

50
Count

25

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F70. Histogram for EQV at H2(t-3)


221

0.00 1.00
30

20
Count

10

0
0.25 0.50 0.75 1.00 1.25 0.25 0.50 0.75 1.00 1.25
ROLLPS5TA ROLLPS5TA

Figure F71. Histogram for ROLLPS5TA at H2(t-3)

0.00 1.00
25

20
Count

15

10

0.00 0.10 0.20 0.30 0.40 0.00 0.10 0.20 0.30 0.40
ROVLTA ROVLTA

Figure F72. Histogram for ROVLTA at H2(t-3)


222

Histograms for Capital Ratio Model Variables at H3(t-1)

0.00 1.00

60
Count

40

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F73. Histogram for EQV at H3(t-1)

0.00 1.00
75

50
Count

25

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBC1AAJ RBC1AAJ

Figure F74. Histogram for RBC1AAJ at H3(t-1)


223

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBC1RWAJ RBC1RWAJ

Figure F75. Histogram for RBC1RWAJ at H3(t-1)

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBCRWAJ RBCRWAJ

Figure F76. Histogram for RBCRWAJ at H3(t-1)


224

Histograms for Capital Ratio Model Variables at H3(t-2)

0.00 1.00

60
Count

40

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F77. Histogram for EQV at H3(t-2)

0.00 1.00

75
Count

50

25

20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00


RBC1AAJ RBC1AAJ

Figure F78. Histogram for RBC1AAJ at H3(t-2)


225

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBC1RWAJ RBC1RWAJ

Figure F79. Histogram for RBC1RWAJ at H3(t-2)

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBCRWAJ RBCRWAJ

Figure F80. Histogram for RBCRWAJ at H3(t-2)


226

Histograms for Capital Ratio Model Variables at H3(t-3)

0.00 1.00
75

50
Count

25

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
EQV EQV

Figure F81. Histogram for EQV at H3(t-3)

0.00 1.00
75

50
Count

25

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBC1AAJ RBC1AAJ

Figure F82. Histogram for RBC1AAJ at H3(t-3)


227

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBC1WAJ RBC1WAJ

Figure F83. Histogram for RBC1WAJ at H3(t-3)

0.00 1.00
60

40
Count

20

0
20.00 40.00 60.00 80.00 20.00 40.00 60.00 80.00
RBCRWAJ RBCRWAJ

Figure F84. Histogram for RBCRWAJ at H3(t-3)


228

APPENDIX G: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODEL
229

Description of Variables in Performance Ratio Model H1(t-1)

Odds 95.0% C.I. Odds

Variables B SE Wald df p. Ratios Upper Lower

INTINCY .208 .596 .122 1 .727 1.231 .383 3.957

INTEXPY .261 .608 .184 1 .668 1.298 .394 4.275

NONIIY 1.080 .673 2.577 1 .108 2.944 .788 11.005

NONIXY -.349 .727 .231 1 .631 .705 .170 2.929

NOIJY -2.932 1.935 2.297 1 .130 .053 .001 2.363

ROA 1.493 1.995 .560 1 .454 4.449 .089 222.095

ROE .074 .063 1.366 1 .243 1.077 .951 1.218

ROEINJR -.021 .035 .339 1 .560 .980 .914 1.050

NTLNLSR .353 .296 1.427 1 .232 1.424 .797 2.542

ELNANTR .000 .000 .002 1 .960 1.000 1.000 1.000

EEFFR -.012 .036 .111 1 .739 .988 .921 1.060

ASTEMPM -.406 .247 2.690 1 .101 .666 .410 1.082

IDDIVNIR -.002 .003 .636 1 .425 .998 .992 1.003

LNATRESR .392 .224 3.069 1 .080 1.480 .954 2.294

LNRESNCR .000 .000 .894 1 .345 1.000 1.000 1.000

NPERFV -.085 .281 .091 1 .763 .919 .530 1.593

NCLNLSR .118 .225 .275 1 .600 1.125 .724 1.750

LNLSDEPR -.009 .029 .102 1 .749 .991 .937 1.048

IDLNCORR .023 .023 1.014 1 .314 1.024 .978 1.071

Constant -1.730 3.166 .299 1 .585 .177


230

APPENDIX H: TOLERANCE AND VARIANCE INFLATION FACTORS


231

Tolerance and Variance Inflation Factors for H11

Variable H11(t-1) H11(t-2) H11(t-3)

Tolerance VIF Tolerance VIF Tolerance VIF

INTINCY .117 8.526 .066 15.057 .090 11.093

INTEXPY .196 5.104 .134 7.469 .179 5.597

NONIIY .135 7.399 .073 13.723 .113 8.869

NONIXY .030 33.575 .020 51.101 .028 36.339

NOIJY .006 173.774 .015 67.203 .013 74.961

ROA .006 178.424 .015 65.965 .014 69.762

ROE .026 39.065 .066 15.169 .039 25.368

ROEINJR .060 16.779 .208 4.797 .074 13.505

NTLNLSR .196 5.104 .296 3.379 .343 2.912

ELNANTR .973 1.028 .958 1.044 .937 1.067

EEFFR .082 12.199 .071 14.091 .073 13.661

ASTEMPM .504 1.983 .493 2.029 .454 2.201

IDDIVNIR .624 1.602 .835 1.197 .395 2.529

LNATRESR .424 2.359 .473 2.115 .633 1.580

LNRESNCR .929 1.076 .870 1.150 .903 1.107

NPERFV .100 10.048 .178 5.609 .097 10.357

NCLNLSR .095 10.543 .184 5.441 .108 9.274

LNLSDEPR .153 6.530 .159 6.287 .104 9.654

IDLNCORR .160 6.253 .146 6.869 .091 11.032


232

APPENDIX I: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODELS
233

Description of Variables in Performance Ratio Model H1(t-2)

Odds 95.0% C.I. Odds Ratio

Variables B SE Wald df p Ratio Upper Lower

INTINCY -1.282 .744 2.970 1 .085 .278 .065 1.192

INTEXPY 1.210 .761 2.523 1 .112 3.352 .754 14.910

NONIIY -.133 .811 .027 1 .870 .875 .178 4.292

NONIXY 1.149 .937 1.506 1 .220 3.156 .503 19.792

NOIJY -2.684 1.774 2.289 1 .130 .068 .002 2.211

ROA 1.094 1.661 .433 1 .510 2.986 .115 77.479

ROE .097 .065 2.219 1 .136 1.102 .970 1.253

ROEINJR .001 .045 .001 1 .979 1.001 .917 1.093

NTLNLSR 1.212 .449 7.292 1 .007 3.360 1.394 8.099

ELNANTR .000 .000 .458 1 .498 1.000 1.000 1.000

EEFFR -.085 .052 2.669 1 .102 .919 .829 1.017

ASTEMPM -.743 .268 7.659 1 .006 .476 .281 .805

IDDIVNIR -.004 .004 1.187 1 .276 .996 .989 1.003

LNATRESR .116 .224 .268 1 .605 1.123 .724 1.742

LNRESNCR .000 .000 1.748 1 .186 1.000 .999 1.000

NPERFV .109 .286 .146 1 .703 1.115 .637 1.951


234

Table (continued).

Description of Variables in Performance Ratio Model H1(t-2)

Odds 95.0% C.I. Odds Ratio

Variables B SE Wald df p Ratio Lower Upper

NCLNLSR -.081 .207 .153 1 .696 .922 .615 1.384

LNLSDEPR -.024 .029 .663 1 .415 .976 .922 1.034

IDLNCORR .052 .025 4.226 1 .040 1.053 1.002 1.106

Constant 7.221 4.402 2.691 1 .101 1368.1


235

APPENDIX J: DESCRIPTION OF VARIABLES IN PERFORMANCE RATIO

MODEL
236

Description of Variables in Performance Ratio Model H1(t-3)

Odds 95.0% C.I. Odds Ratio

Variables B SE Wald df p Ratio Lower Upper

INTINCY -.661 .482 1.882 1 .170 .516 .201 1.328

INTEXPY .837 .508 2.718 1 .099 2.309 .854 6.246

NONIIY -.358 .470 .579 1 .447 .699 .278 1.757

NONIXY .695 .535 1.685 1 .194 2.004 .702 5.723

NOIJY -2.449 1.318 3.452 1 .063 .086 .007 1.144

ROA 3.008 1.252 5.770 1 .016 20.243 1.739 235.598

ROE .016 .055 .089 1 .766 1.016 .913 1.131

ROEINJR .002 .043 .002 1 .966 1.002 .921 1.090

NTLNLSR 1.041 .360 8.346 1 .004 2.831 1.397 5.736

ELNANTR .000 .000 .842 1 .359 1.000 1.000 1.001

EEFFR -.008 .032 .056 1 .813 .992 .932 1.057

ASTEMPM -.681 .260 6.857 1 .009 .506 .304 .842

IDDIVNIR -.002 .006 .085 1 .770 .998 .987 1.009

LNATRESR .150 .177 .719 1 .396 1.162 .822 1.643

LNRESNCR .000 .000 .449 1 .503 1.000 1.000 1.000

NPERFV -.274 .226 1.472 1 .225 .761 .489 1.183

NCLNLSR .242 .176 1.893 1 .169 1.273 .903 1.796


237

Table (continued).

Description of Variables in Performance Ratio Model H1(t-3)

Odds 95.0% C.I. Odds Ratio

Variables B SE Wald df p Ratio Lower Upper

LNLSDEPR -.062 .034 3.302 1 .069 .940 .879 1.005

IDLNCORR .087 .030 8.426 1 .004 1.091 1.029 1.157

Constant -1.648 3.030 .296 1 .587 .192


238

APPENDIX K: CORRELATION MATRIX


239

Table K1

Correlation Matrix H11(t-1)

Constant INTINCY INTEXPY NONIIY NONIXY NONIJY

Constant 1.000 -.638 .469 -.492 .554 -.138

INTINCY -.638 1.000 -.929 .790 -.932 -.063

INTEXPY .469 -.929 1.000 -.736 .909 .049

NONIIY -.492 .790 -.736 1.000 -.868 -.078

NONIXY .554 -.932 .909 -.868 1.000 .030

NOIJY -.138 -.063 .049 -.078 .030 1.000

ROA .098 -.112 .140 -.103 .130 -.890

ROE .102 .004 -.045 .010 -.004 -.076

ROEINJR -.092 -.030 .027 -.083 .070 .046

NTLNLSR -.059 -.264 .276 .-298 .229 .221

ELNANTR .056 .007 -.025 -.021 -.006 .023

EEFFR -.795 .756 -.722 .635 -.821 .125

ASTEMPM -.511 .259 -.216 .251 -.137 .217

IDDIVNIR -.199 -.010 .034 -.067 .054 .020

LNATRESR -.182 -.054 .099 -.010 .055 .059

LNRESNCR .031 .002 -.008 .031 -.004 -.011

NPERFV .073 .167 -.213 .102 -.235 .002

NCLNLSR .076 -.288 .317 -.181 .356 -.050

LNLSDEPR -.022 -.110 .081 -.072 .090 .109

IDLNCORR .024 -.058 .060 -.034 .052 -.092


240

Table K1 (continued).

Correlation Matrix H11(t-1)

ROA ROE ROEINJR NTLNLSR ELNANTR EEFFR

Constant .098 .102 -.092 -.059 .056 -.795

INTINCY -.112 .004 -.030 -.264 .007 .756

INTEXPY .140 -.045 .027 .276 -.025 -.722

NONIIY -.103 .010 -.083 -.298 -.021 .635

NONIXY .130 -.004 .070 .229 -.006 -.821

NOIJY -.890 -.076 .046 .221 .023 .125

ROA 1.000 -.273 -.018 -.050 -.013 -.127

ROE -.273 1.000 -.335 -.055 -.083 -.088

ROEINJR -.018 -.335 1.000 -.015 .041 .054

NTLNLSR -.050 -.055 -.015 1.000 -.018 -.018

ELNANTR -.013 -.083 .041 -.018 1.000 -.021

EEFFR -.127 -.088 .054 -.018 -.021 1.000

ASTEMPM -.251 .036 .013 -.019 -.093 .248

IDDIVNIR .010 -.216 .637 -.158 .017 .122

LNATRESR -.137 .251 -.021 -.060 -.026 -.019

LNRESNCR -.028 .055 -.023 .023 .044 -.038

NPERFV .000 -.028 -.037 -.077 .009 .183

NCLNLSR .077 -.003 .011 .037 -.004 -.361

LNLSDEPR -.133 .093 .012 .119 .104 -.107

IDLNCORR .161 -.118 -.009 -.048 -.111 .009


241

Table K1 (continued).

Correlation Matrix H11(t-1)

ASTEMPM IDDIVNIR LNATRESR LNRESNCR

Constant -.511 -.199 -.182 .031

INTINCY .259 -.010 -.054 .002

INTEXPY -.216 .034 .099 -.008

NONIIY .251 -.067 -.010 .031

NONIXY -.137 .054 .055 -.004

NOIJY .217 .020 .059 -.011

ROA -.251 .010 -.137 -.028

ROE .036 -.216 .251 .055

ROEINJR .013 .637 -.021 -.023

NTLNLSR -.019 -.158 -.060 -.023

ELNANTR -.093 .017 -.026 .044

EEFFR .248 .122 -.019 -.038

ASTEMPM 1.000 .089 .061 -.004

IDDIVNIR .089 1.000 .060 -.021

LNATRESR .061 .060 1.000 -.056

LNRESNCR -.004 -.021 -.056 1.000

NPERFV -.078 -.070 -.126 -.031

NCLNLSR .017 -.003 .006 .094

LNLSDEPR .111 .064 .137 .031

IDLNCORR -.182 -.064 -.054 -.040


242

Table K1 (continued).

Correlation Matrix H11(t-1)

NPERFV NCLNLSR LNLSDEPR IDLNCORR

Constant .073 .076 -.022 .024

INTINCY .167 -.288 -.110 -.058

INTEXPY -.213 .317 .081 .060

NONIIY .102 -.181 -.072 -.034

NONIXY -.235 .356 .090 .052

NOIJY .002 -.050 .109 -.092

ROA .000 .077 -.133 .161

ROE -.028 -.003 .093 -.118

ROEINJR -.037 .011 .012 -.009

NTLNLSR -.037 .011 .012 -.009

ELNANTR .009 -.004 .104 -.111

EEFFR .183 -.361 -.107 .009

ASTEMPM -.078 .017 .111 -.182

IDDIVNIR -.070 -.003 .064 -.064

LNATRESR -.126 .006 .137 -.054

LNRESNCR -.031 .094 .031 -.040

NPERFV 1.000 -.896 -.105 -.070

NCLNLSR -.896 1.000 .090 .097

LNLSDEPR -.105 .090 1.000 -.910

IDLNCORR -.070 .097 -.910 1.000


243

Table K2

Correlation Matrix H11(t-2)

Constant INTINCY INTEXPY NONIIY NONIXY NONIJY

Constant 1.000 -.779 .580 -.616 .724 -.268

INTINCY -.779 1.000 -.898 .788 -.930 .033

INTEXPY .580 -.898 1.000 -.751 .899 .051

NONIIY -.616 .788 -.751 1.000 -.885 .082

NONIXY .724 -.930 .899 -.885 1.000 -.097

NOIJY -.268 .033 .051 .082 -.097 1.000

ROA .199 -.162 .118 -.188 .204 -.865

ROE .097 -.017 -.057 -.103 .030 -.173

ROEINJR -.004 -.004 -.002 .036 -.013 .051

NTLNLSR .091 -.364 .341 -.366 .342 .211

ELNANTR .088 -.066 .012 -.032 .043 -.039

EEFFR -.868 .811 -.765 .737 -.891 .230

ASTEMPM -.504 .353 -.318 .287 -.231 .110

IDDIVNIR -.115 .083 -.075 .078 -.072 .020

LNATRESR -.088 -.022 .050 .036 -.013 .013

LNRESNCR -.127 .094 -.058 .030 -.046 .111

NPERFV .152 -.048 -.021 .052 -.039 .046

NCLNLSR -.103 .025 .034 -.051 .055 -.049

LNLSDEPR .097 -.037 .141 -.046 .076 .067

IDLNCORR .162 -.119 -.061 -.036 .027 -.070


244

Table K2 (continued).

Correlation Matrix H11(t-2)

ROA ROE ROEINJR NTLNLSR ELNANTR EEFFR

Constant .199 .097 -.004 .091 .088 -.868

INTINCY -.162 -.017 -.004 -.364 -.066 .811

INTEXPY .118 -.057 -.003 .341 .012 -.765

NONIIY -.188 -.103 .036 -.366 -.032 .737

NONIXY .204 .030 -.013 .342 .043 -.891

NOIJY -.865 -.173 .051 .211 -.039 .230

ROA 1.000 -.174 -.083 -.103 .042 -.195

ROE -.174 1.000 -.432 .098 .037 -.059

ROEINJR .083 -.432 1.000 -.022 -.013 -.005

NTLNLSR -.103 .098 -.022 1.000 -.010 -.153

ELNANTR .042 .037 -.013 -.010 1.000 -.041

EEFFR -.195 -.059 -.005 -.153 -.041 1.000

ASTEMPM -.138 .040 -.017 -.065 -.021 .323

IDDIVNIR -.054 -.274 .617 -.087 .009 .088

LNATRESR -.069 .134 -.027 -.150 .051 -.002

LNRESNCR -.102 -.053 .033 .139 -.044 .061

NPERFV -.004 -.043 -.006 -.096 .075 .011

NCLNLSR .024 -.013 .040 .056 -.075 -.061

LNLSDEPR -.069 -.075 .107 .067 -.052 -.088

IDLNCORR .092 .062 -.073 .032 .031 .014


245

Table K2 (continued).

Correlation Matrix H11(t-2)

ASTEMPM IDDIVNIR LNATRESR LNRESNCR

Constant -.504 -.115 -.088 -.127

INTINCY .353 .083 .022 .094

INTEXPY -.318 -.075 .050 -.058

NONIIY .287 .078 .039 .030

NONIXY -.231 -.072 -.013 -.046

NOIJY .110 .020 .013 .111

ROA -.138 -.054 -.069 -.102

ROE .040 -.274 .134 -.053

ROEINJR -.017 .617 -.027 .033

NTLNLSR -.065 -.087 -.150 .139

ELNANTR -.021 .009 .051 -.044

EEFFR .323 .068 -.002 .061

ASTEMPM 1.000 .126 .023 .014

IDDIVNIR .128 1.000 .053 .013

LNATRESR .023 .053 1.000 -.214

LNRESNCR .014 .013 -.214 1.000

NPERFV -.063 .031 -.019 -.103

NCLNLSR .028 .015 -.121 .202

LNLSDEPR .092 -.015 .101 .051

IDLNCORR -.206 .014 -.045 -.046


246

Table K2 (continued).

Correlation Matrix H11(t-2)

NPERFV NCLNLSR LNLSDEPR IDLNCORR

Constant .152 -.103 -.097 .162

INTINCY -.048 .025 -.037 -.119

INTEXPY -.021 .034 .141 -.061

NONIIY .052 -.051 -.046 -.036

NONIXY -.039 .055 .076 .027

NOIJY .046 -.049 .067 -.070

ROA -.004 .024 -.069 .092

ROE -.043 -.013 -.075 .062

ROEINJR -.006 .040 .107 -.073

NTLNLSR -.096 .056 .067 .032

ELNANTR .075 -.075 -.052 .031

EEFFR .011 -.061 -.088 .014

ASTEMPM -.063 .028 .092 -.206

IDDIVNIR .031 .015 -.015 .014

LNATRESR -.019 -.121 .101 -.045

LNRESNCR -.103 .202 .051 -.046

NPERFV 1.000 -.901 -.226 .094

NCLNLSR -.901 1.000 .192 -.057

LNLSDEPR -.226 .192 1.000 -.899

IDLNCORR .094 -.057 -.899 1.000


247

Table K3

Correlation Matrix H11(t-3)

Constant INTINCY INTEXPY NONIIY NONIXY NONIJY

Constant 1.000 -.556 .271 -366 .475 -.244

INTINCY -.556 1.000 -794 .738 -.895 -.108

INTEXPY .271 -.794 1.000 -.679 .821 -.043

NONIIY -.366 .738 -.679 1.000 -.858 .069

NONIXY .475 -.895 .821 -.858 1.000 1.000

NOIJY -.244 -.108 .036 -.043 .069 -.870

ROA .147 -.109 .181 -.169 .129 -.218

ROE .147 .001 -.060 -.073 -.028 .221

ROEINJR -.249 .020 .061 .090 .025 -.108

NTLNLSR -.034 -.470 .488 -.441 .435 .134

ELNANTR .016 -.145 .131 -.143 .125 .204

EEFFR -.807 .605 -.544 .542 -.730 .417

ASTEMPM -.428 .184 -.195 .181 -.062 .097

IDDIVNIR -.247 .094 -.041 .140 -.067 .216

LNATRESR -.074 -.317 .269 -.235 .272 -.031

LNRESNCR -.054 .054 .040 .040 -.020 .089

NPERFV .122 .056 -.055 .061 -.065 -.053

NCLNLSR -.068 -.044 .012 -.078 .060 .102

LNLSDEPR -.124 .009 .083 .023 .003 -.062

IDLNCORR .143 -.168 -.057 -.099 .092 -.062


248

Table K3 (continued).

Correlation Matrix H11(t-3)

ROA ROE ROEINJR NTLNLSR ELNANTR EEFFR

Constant .147 .147 -.249 -.034 .016 -.807

INTINCY -.109 .001 .020 -.470 -.145 .605

INTEXPY .181 -.060 .061 .488 .131 -.544

NONIIY -.169 -.073 .090 -.441 -.143 .542

NONIXY .129 -.028 .025 .435 .125 -.730

NOIJY -.870 -.218 .221 -.108 .134 .204

ROA 1.000 -.043 -.133 .323 -.079 -.152

ROE -.043 1.000 -.784 .074 -.048 -.037

ROEINJR -.133 -.784 1.000 .006 .055 .102

NTLNLSR .323 .074 .006 1.000 .089 -.067

ELNANTR -.079 -.048 .055 .089 1.000 -.028

EEFFR -.152 -.037 .102 -.067 -.028 1.000

ASTEMPM -.440 -.079 .225 -.100 .015 .225

IDDIVNIR -.071 -.557 .725 -.035 .008 .145

LNATRESR -.110 -.051 .087 .145 .060 -.078

LNRESNCR .001 .072 -.029 .028 -.048 -.009

NPERFV -.174 .048 .099 -.157 -.029 -.030

NCLNLSR .099 .045 -.149 .014 .033 -.010

LNLSDEPR -.154 .034 .011 -.035 .046 -.046

IDLNCORR .163 -.072 .009 .107 -.040 .018


249

Table K3 (continued).

Correlation Matrix H11(t-3)

ASTEMPM IDDIVNIR LNATRESR LNRESNCR

Constant -.428 -.247 -.074 -.054

INTINCY .184 .094 -.317 .054

INTEXPY -.195 -.041 .269 .040

NONIIY .181 .140 -.235 .040

NONIXY -.062 -.067 .272 -.020

NOIJY .417 .097 .216 -.031

ROA -.440 -.071 -.110 .001

ROE -.079 -.557 -.051 .072

ROEINJR .225 .725 .087 -.029

NTLNLSR -.100 -.035 .145 .028

ELNANTR .015 .008 .060 -.048

EEFFR .225 .145 -.078 -.009

ASTEMPM 1.000 .182 .046 .011

IDDIVNIR .182 1.000 .039 -.046

LNATRESR .046 .039 1.000 -.062

LNRESNCR .011 -.046 -.062 1.000

NPERFV .070 .170 -.105 .036

NCLNLSR -.078 -.217 -.009 .046

LNLSDEPR .108 -.048 .102 .134

IDLNCORR -.170 .054 .018 -.198


250

Table K3 (continued).

Correlation Matrix H11(t-3)

NPERFV NCLNLSR LNLSDEPR IDLNCORR

Constant .122 -.068 -.124 .143

INTINCY .056 -.044 .009 -.168

INTEXPY -.055 .012 .083 -.057

NONIIY .061 -.078 .023 -.099

NONIXY -.065 .060 .003 .092

NOIJY .089 -.053 .102 -.062

ROA -.174 .099 -.154 .163

ROE .048 .045 .034 -.072

ROEINJR .099 -.149 .011 .009

NTLNLSR -.157 .014 -.035 .107

ELNANTR -.029 .033 .046 -.040

EEFFR -.030 -.010 -.046 .018

ASTEMPM .070 -.078 .108 -.170

IDDIVNIR .170 -.217 -.048 .054

LNATRESR -.105 -.009 .102 .018

LNRESNCR .036 .046 .134 -.198

NPERFV 1.000 -.894 -.140 .000

NCLNLSR -.894 1.000 .111 .019

LNLSDEPR -.140 .111 1.000 -.919

IDLNCORR .000 .019 -.919 1.000


251

APPENDIX L: VALIDATION ANALYSIS


252

Validation Analysis

Alternative Chi-square -2 Log Likelihood Percentage Accuracy

Hypotheses Classification

Validation Validation Validation Validation Validation Validation

Sample 1 Sample 2 Sample 1 Sample 2 Sample 1 Sample 2

H11(t-1) 52.025 55.109 133.739 127.882 76.1% 75.8%

H11(t-1) 73.933 42.062 85.274 128.053 81.7% 70.7%

H11(t-3) 46.949 34.589 116.498 131.733 75.4% 66.7%

H21(t-1) 16.551 16.694 167.719 166.297 60.9% 62.9%

H21(t-2) 21.133 22.124 163.237 160.867 68.4% 65.2%

H21(t-3) 15.777 19.368 168.592 163.623 65.4% 61.4%

H31(t-1) 13.498 14.783 172.265 168.208 64.9% 64.4%

H31(t-2) 15.291 13.370 170.472 169.621 65.7% 63.6%

H31(t-3) 13.864 10.884 171.900 172.107 65.7% 58.3%


253

APPENDIX M: VALIDATION LIFT


254

Table M1

Validation Lift H11

H11(t-1) H11(t-2) H11(t-3)

Percentile Validation Validation Validation Validation Validation Validation

Group Group 1 Group 2 Group 1 Group 2 Group 1 Group 2

1 .9231 1.0000 .9231 1.0000 .6923 .9231

2 .7692 .7692 .8462 .5385 .6923 .6154

3 .7143 6154 .5714 .5385 .7857 .6923

4 .5385 .6429 .6923 .5000 .8462 .5714

5 .5714 .5385 .6123 .6923 .4615 .3077

6 .3846 .3846 .5000 .3846 .2857 .5385

7 .2143 .3571 .3077 .5000 .5385 .4286

8 .3077 .3077 .5000 .3846 .1429 .4615

9 .2143 .2308 .0000 .4615 .3846 .3077

10 .3846 .1538 .0769 .0000 .2308 .1538

Total .5000 .5000 .5038 .5000 .5038 .5000


255

Table M2

Validation Lift H21

H21(t-1) H21(t-2) H21(t-3)

Percentile Validation Validation Validation Validation Validation Validation

Group Group 1 Group 2 Group 1 Group 2 Group 1 Group 2

1 .8462 .8462 .9231 .7692 .7692 .8462

2 .6923 .3846 .8462 .8462 .9231 .6923

3 .7143 .7692 .7143 .3846 .6429 .3846

4 .6154 .5714 .3846 .5714 .6154 .5714

5 .5385 .8462 .4615 .6154 .3846 .6154

6 .3571 .3077 .5000 .6154 .2857 .5385

7 .2308 .4286 .1538 .3571 .4615 .4386

8 .4286 .3846 .2857 .5385 .2857 .5385

9 .2308 .3846 .4615 .2308 .3077 .2308

10 .3846 .0769 .3077 .0769 .3846 .1538

Total .5038 .5000 .5038 .5000 .5038 .5000


256

Table M3

Validation Lift H31

H31(t-1) H31(t-2) H31(t-3)

Percentile Validation Validation Validation Validation Validation Validation

Group Group 1 Group 2 Group 1 Group 2 Group 1 Group 2

1 1.0000 .5385 .8462 .6154 .6923 .6923

2 .3846 .6154 .6154 .5385 .6923 .6923

3 .7857 .6154 .7143 .8462 .5714 .4615

4 .3846 .6429 .6154 .5714 .5385 .6429

5 .7143 .4615 .5000 .4615 .7143 .4615

6 .5385 .6923 .5385 .4615 .6923 .3846

7 .3571 .4286 .2143 .6429 .3571 .6429

8 .3077 .2308 .4615 .1538 .3077 .3846

9 .2143 .5385 .2143 .3846 .2143 .2308

10 .3077 .2308 .3077 .3077 .2308 .3846

Total .5000 .5000 .5000 .5000 .5000 .5000


257

APPENDIX N: CASEWISE LIST


258

Casewise List

Alternative Selected Observed Predicted Temporary Variable

Hypotheses Case Status Fraud Predicted Group Resid ZResid

77 S 0** .105 0 .895 2.924

120 S 0** .615 1 -.615 -1.265

H11(t-1) 128 S 0** ,848 1 -.848 -2.363

163 S 1** .131 0 .869 2.572

184 S 0** ,854 1 -.854 -2.420

51 S 1** .135 0 .865 2.531

H11(t-2) 79 S 1** .148 0 .852 2.402

200 S 0** .874 1 -.874 -2.639

30 S 0** .908 1 -.908 -3.133

H11(t-3) 42 S 0** .886 1 -.886 -2.793

135 S 1** .155 0 .845 2.337

H21(t-1) 39 S 1** .103 0 .897 2.954

H21(t-2) 39 S 1** .097 0 .903 3.045

H21(t-3) 33 S 1** .121 0 .879 2.692

H31(t-1) 161 S 1** .143 0 .857 2.449

21 S 1** .141 0 .859 2.467


H31(t-2)
161 S 1** .128 0 .872 2.605

H31(t-3) 225 S 1** .022 0 .978 6.592

** Misclassified cases
259

APPENDIX O: ANALYSIS OF OUTLIERS


260

Analysis of Outliers

Alternative Chi-square df p

Hypotheses Full Less Full Less Full Less

date Outliers date Outliers date Outliers

H11(t-1) 71.080 90.201 19 19 .000* .000*

H11(t-2) 83.978 93,121 19 19 .000* .000*

H11(t-3) 57.888 71.232 19 19 .000* .000*

H21(t-1) 32.652 36.009 4 4 .000* .000*

H21(t-2) 42.391 45.853 4 4 .000* .000*

H21(t-3) 33.976 37.209 4 4 .000* .000*

H31(t-1) 24.577 27.307 4 4 .000* .000*

H31(t-2) 26.837 33.027 4 4 .000* .000*

H31(t-3) 23.902 31.036 4 4 .000* .000*


261

Table (continued).

Analysis of Outliers

Alternative -2 Log likelihood Cox & Snell R2 Nagelkerke R2

Hypotheses Full Less Full Less Full Less

dataset Outliers dataset Outliers dataset Outliers

H11(t-1) 263.593 237.401 .255 .317 .340 .423

H11(t-2) 245.354 232.143 .297 .327 .397 .437

H11(t-3) 271.898 254.338 .216 .261 .288 ,349

H21(t-1) 334.712 329.972 .116 .128 .156 .170

H21(t-2) 324.973 320.129 .148 .159 .197 .213

H21(t-3) 333.388 328.772 .120 .131 .160 .175

H31(t-1) 344.178 340.057 .088 .098 .118 .131

H31(t-2) 341.917 332.939 .096 .118 .128 .157

H31(t-3) 344.852 336.329 .086 .111 .115 .147

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