Externalities of Financial Statement Fraud on the Incoming Accounting Labor Force

• Published date: 01 December 2023
• Author: ROBERT R. CARNES,DANE M. CHRISTENSEN,PAUL E. MADSEN
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/1475-679X.12501

DOI: 10.1111/1475-679X.12501

Journal of Accounting Research

Vol. 61 No. 5 December 2023

Printed in U.S.A.

Externalities of Financial Statement

Fraud on the Incoming Accounting

Labor Force

ROBERT R. CARNES,∗DANE M. CHRISTENSEN,†

AND PAUL E. MADSEN‡

Received 24 March 2020; accepted 7 July 2023

ABSTRACT

Financial statement fraud generates many negative effects, including reduc-

ing people’s willingness to participate in the stock market. If it also stigma-

tizes accounting, it may similarly adversely affect the quantity and quality of

workers willing to become accountants, thereby potentially creating negative

effects for years to come. We examine the impact of fraud on the labor force

entering the accounting profession, which is a key input into the production

of accounting information (i.e., the output). Using data describing millions

of college students across the United States, we find incoming students are

actually more likely to major in accounting when local frauds occur during

their formative years. These students are also more likely to have attributes

∗University of Florida; †University of Oregon; ‡University of Florida

Accepted by Regina Wittenberg Moerman. This paper has benefited from helpful com-

ments and suggestions from John Barrios, Matt Baugh (discussant), Vanessa Billingsley, Ken

Bills, Robert Bowen, Brant Christensen, David Godsell, Henry Friedman, Bud Fennema, Jane

Jollineau, Ed Ketz, Robert Knechel, Allison Koester (discussant), Phil Lamoreaux, Mike May-

berry,Joe Pacelli, Mike Ricci, Tatiana Sandino, Timothy Shields, Jayanthi Sunder, Brady Twedt,

and workshop participants at Chapman University, the University of Florida, the 2022 AAA

FARS Midyear Meeting, the 2022 AAA Audit Midyear Meeting, the 2021 Brigham Young Uni-

versity Accounting Research Symposium, the 2021 Stanford University Labor and Accounting

Conference, and the 2020 AAA Annual Meeting. Paul E. Madsen gratefully acknowledges the

support of the Deloitte Foundation Professorship. We also gratefully acknowledge the finan-

cial support from our respective institutions. An online appendix to this paper can be down-

loaded at https://www.chicagobooth.edu/jar-online-supplements.

1531

© 2023 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1532 r. r. carnes, d. m. christensen, and p. e. madsen

desired by the accounting profession (e.g., high academic aptitude) and are

more likely to subsequently serve in public accounting and become Certified

Public Accountants. In the context of other fields (i.e., all college majors), we

find that fraud similarly spurs interest in other business disciplines, but not

in majors outside of business schools. Those attracted to other business dis-

ciplines, however, generally possess different traits. Specifically, students en-

tering accounting are distinctively more likely to exhibit values espoused by

the accounting profession, including a predisposition to public service and

less commercial orientation. Thus, nonpecuniary motives appear to uniquely

drive accounting student enrollment following fraud. Collectively, our find-

ings suggest that, while fraud is unmistakably bad, it appears to have the posi-

tive unintended consequence of attracting labor into business disciplines and,

in accounting, increasing the prevalence of desirable traits among entrants.

JEL codes: I23, K42, M41, R10

Keywords: financial statement fraud; accounting; labor force; higher

education

1. Introduction

Reactions to financial statement fraud shape the practice of public ac-

counting, including the laws and standards we know today (e.g., Clikeman

[2019], Hail, Tahoun, and Wang [2018], Zeff [2003a, b]).1However, while

the true foundation of the accounting profession is—and always will be—

people (CAQ [2018]), it is not clear how financial statement fraud influ-

ences accounting’s human capital. In this study,we investigate whether and

how financial statement fraud shapes the practitioners of public account-

ing. Specifically, we examine the impact of financial statement fraud on

the labor force entering the accounting profession, which is a key input

into the production of accounting information (i.e., the output). Using

data describing millions of college students across the United States, we

empirically evaluate how financial statement fraud influences the quantity

and quality of students majoring in accounting and the trajectories of their

post-graduation careers.

Whether and how financial statement fraud affects incoming accounting

labor is unclear for several reasons. First, we have a limited understanding

of the broader spillover effects of fraud (Coates and Srinivasan [2014]).

Regarding the labor market, prior literature finds fraud directly impacts

the careers of fraudsters (Karpoff, Lee, and Martin [2008]) and their

co-workers (Choi and Gipper [2021], Groysberg, Lin, and Serafeim

[2020]), yet we have a limited understanding of how fraud impacts the la-

bor force more broadly. Second, because frauds are historically followed

by regulation that shifts nationwide demand for accounting services (Hail,

1For ease of exposition, we use the terms “financial statement fraud” and “fraud” in-

terchangeably to refer to intentional misreporting of the financial statements and related

footnotes.

externalities of financial statement fraud1533

Tahoun, and Wang [2018]), it is empirically challenging to observe the dis-

tinct effects of fraud in the labor market. Finally, while fraud is likely rel-

evant to incoming accounting labor, there are competing forces at work.

Fraud may stigmatize accounting and reduce its appeal, or in contrast, it

may alert students to the importance of accounting and attract talent.

Fraud may also change the mix of character traits among students in-

terested in accounting. Theory on career selection suggests that salient

events such as frauds are likely to influence the types of students that se-

lect into accounting based on how the news of the events interacts with

students’ perceptions of themselves and their potential careers. The litera-

ture conceptualizes career and degree selection as a matching problem in

which students pursue majors and careers that they believe are congruent

with their personal characteristics (Gottfredson [1981], Holland [1997],

Akerlof and Kranton [2000], [2002], Gottfredson [2005]). In an Akerlof

and Kranton [2000] economic framework, students seek to maximize their

utility, or identity payoffs, based on how their identities align with a ca-

reer after considering their beliefs about both pecuniary factors (e.g., the

cost of training and expected earnings) and nonpecuniary factors (e.g., the

quality of the match between a career’s values and a student’s personal val-

ues). Research shows that students form their beliefs in an environment

characterized by uncertainty and limited information, where they readily

revise their understanding and preferences after exposure to new informa-

tion and experiences (Malmendier and Nagel [2011], Baker et al. [2018],

Fricke, Grogger, and Steinmayr [2018]). Within this context, information

about local frauds could influence incoming accounting labor through a

saliency channel by drawing attention to the profession. It could also influ-

ence accounting labor through a learning channel by giving students ac-

cess to new information about the profession. With many potential forces

at play, however, whether and how students process this information is ulti-

mately an empirical question.

We test the impact of fraud on students’ choice to major in account-

ing using large-scale survey data from the Higher Education Research In-

stitute (HERI). These data enable us to conduct empirical tests with sev-

eral strengths. First, our sample spans over 20 years, which allows us to

generalize across several fraud waves and regulatory regimes. Second, our

sample includes millions of college student observations (from 953 uni-

versities and all 50 U.S. states), thereby allowing us to generalize across

the population of U.S. college students. Third, our sample includes data

from all academic majors, which allows us to make relative comparisons

of enrollment trends in accounting versus other disciplines. Fourth, the

HERI surveys collect data on a broad array of student attributes that en-

able us to empirically examine a set of both quantitative and qualitative

characteristics that drive student self-selection into college majors. Finally,

fraud varies by geographical location and time (Glaeser, Sacerdote, and

Scheinkman [1996], Parsons, Sulaeman, and Titman [2018]) and is more

salient to the communities surrounding fraud firms’ headquarters (e.g.,