Fraud survival in nonprofit organizations: Empirical evidence

• Published date: 01 September 2018
• DOI: http://doi.org/10.1002/nml.21313
• Date: 01 September 2018

RESEARCH ARTICLE

Fraud survival in nonprofit organizations:

Empirical evidence

Deborah S. Archambeault | Sarah Webber

Accounting, University of Dayton, Dayton, Ohio

Correspondence

Sarah Webber, University of Dayton—

Accounting, 410 Miriam Hall 300 College Park

Dayton, Dayton, OH 45469-2242.

Email: swebber1@udayton.edu

This study examines the survival of nonprofit organiza-

tions after the discovery of a fraud. Literature on non-

profit fraud claims that fraud has a destructive impact on

nonprofit organizations. This study is the first to provide

empirical evidence of the impact of fraud on a nonprofit

organization's survival, and to analyze the significance of

underlying organizational and fraud factors. An analysis

of 115 nonprofit organizations experiencing a fraud

shows that over one fourth of these organizations did not

survive at least 3 years beyond the publication of the

fraud, a rate considerably higher than the typical non-

profit failure rate. This article investigates the characteris-

tics of surviving organizations and finds that older and

larger organizations are more likely to survive, indicating

the liabilities of newness and smallness hold in fraud sur-

vival situations. In cases where an executive-level perpe-

trator committed the fraud, or where the organization

victimized the public, the organization was less likely to

survive. These findings suggest nonprofit organizations,

particularly those that are new or small, could benefit by

implementing governance policies and procedures that

are consistent with those employed by more established

organizations.

KEYWORDS

fraud, Internal Revenue Service (IRS) 990, nonprofit,

survival

1|INTRODUCTION

Voluntary contributions are the primary means by which nonprofit organizations receive necessary

resources (Parsons, 1956). Because of their dependence on public support, gaining legitimacy with

the public is an important aspect of increasing a nonprofit organization's chances for survival

(Meyer & Rowan, 1977). Reliance on public trust means these organizations may be judged by

Received: 8 July 2017 Revised: 1 March 2018 Accepted: 7 March 2018

DOI: 10.1002/nml.21313

Nonprofit Management and Leadership. 2018;29:29–46. wileyonlinelibrary.com/journal/nml © 2018 Wiley Periodicals, Inc. 29

higher standards than for-profit organizations (Sisco, 2012), and maintaining trust and a positive rep-

utation are vital to their success (Jones-Bodie, 2008). In addition to financial support from individ-

uals and grants, nonprofits must seek volunteers and connections to the community. Jeavons (2001)

describes the importance of nonprofits establishing trust with their donors, clients, and the public at

large, noting that failure to maintain trust prevents nonprofits from serving a critical role in society.

Nothing threatens trust for nonprofits as much as having a public scandal involving unethical behav-

ior by the organization or its managers (Jeavons, 2001, p. 118).

According to the most recent report by the Association of Certified Fraud Examiners (ACFE),

fraud is a persistent and costly problem in both the for-profit and nonprofit sectors, with an esti-

mated 5% of an organization's revenues lost to fraud each year (ACFE, 2016, p. 4). The ACFE

acknowledges that the total cost to the victim organizations is likely much more than simply lost

revenue, and their loss estimates do not attempt to quantify additional indirect costs (including repu-

tational harm and loss of stakeholder relationships) that are often a consequence of a fraud discovery

(ACFE, 2016, p. 9). Although nonprofit organizations constitute only 10.1% of that study's sample

(ACFE, 2016, p. 31), the issue of fraud and its consequences to the nonprofit sector is significant.

Fraud losses result in fewer resources available to carry out the nonprofit organization's mission

(Greenlee, Fischer, Gordon, & Keating, 2007). While this immediate negative consequence is obvi-

ous, the longer-term consequences to the organization are less clear, and have not been tested

empirically.

Empirical research on fraud in the nonprofit sector has traditionally lagged behind the volume of

data on fraud in for-profit organizations, but some progress has been made in documenting the inci-

dence of fraud in nonprofit organizations (Archambeault, Webber, & Greenlee, 2015; Fremont-

Smith, 2004; Fremont-Smith & Kosaras, 2003; Gibelman & Gelman, 2001, 2002). Although these

studies provide insight into the incidence of fraud in the nonprofit sector, there is an absence of

empirical evidence on the consequences of these frauds after their discovery. Concerns about the

adverse effects of fraud, scandal, or other negative publicity on nonprofit organizations are well

documented (Auger, 2011; Burt, 2014; Greenlee et al., 2007; Jeavons, 2001; Sisco, 2012), and some

empirical evidence shows that donor support declines with negative news about a nonprofit organi-

zation (Petrovits, Shakespeare, & Shih, 2011). A nonprofit organization's reputation is so important

that staining it with a scandal can ultimately lead to the organization's demise (Hager & Searing,

2014). Although the connection between public reporting of a fraud and the demise of an organiza-

tion is logical, it has not been examined empirically. This leads to our first research question.

Research Question #1: Is a publicly reported fraud negatively related to a nonprofit

organization's survival?

We address this question by analyzing data for a sample of 115 nonprofit organizations with

publicized frauds in comparison to typical survival rates for nonprofit organizations. We also seek

to gain a better understanding of the factors that distinguish surviving organizations from nonsurvi-

vors, leading to our second research question.

Research Question #2: What factors are associated with a nonprofit organization's sur-

vival of a publicly reported fraud?

Drawing from the literatures on fraud and organizational theory, we identify organizational and

fraud factors that we hypothesize may have an effect on postfraud survival. This study is the first, to

our knowledge, to provide empirical evidence on the survival of nonprofit organizations after the

public reporting of a fraud. By comparing the characteristics of surviving and nonsurviving

30 ARCHAMBEAULT AND WEBBER