Non-GAAP Reporting Decisions and the Enhanced Fraud Triangle: The Role of Capability

Abstract

Based on an experiment with 92 US public company financial executives, we use the enhanced fraud triangle framework (pressure, opportunity and capability) to understand controllers' response to CFO pressure to opportunistically manipulate non-GAAP earnings. Overall, we find that capability factors are associated with controllers' behaviour in our experimental setting, with some evidence of pressure effects as well. Specifically, we find that controller bonus type, perceptions of the CEO's role in pressure from the CFO, the perceived ethicality of the action, the fairness of the decision process and whether participants have seen a similar situation in practice are significantly related to controllers' decisions. Overall, our results and other recent research findings point to the important role of capability in understanding and assessing fraud risk. We hope that the findings will be useful to auditors, and we encourage auditing standard setters to consider emphasizing capability in their fraud-related standards.