Local Crime Environment and Corporate Financial Misconduct Using Benford’s Law

Abstract

This study analyzes the impact of the local crime environment on the likelihood of a firm engaging in financial misconduct. Using the Benford Score metric, which assesses the extent to which a firm’s financial statement number distribution diverges from a theoretical distribution, I find that firms headquartered in high crime areas are associated with greater financial misconduct. The link is more pronounced in firms that offer more stock-based executive compensation to their executives or practice weak corporate governance, and change in the crime rate is associated with change in the firm’s financial misconduct. My results support the social norm, social learning, and environmental criminology theories, as well as the fraud triangle, and are robust to a number of alternative specifications and approaches. The evidence implies that a firm’s environment influences the level of corporate financial misconduct.