Financial statement fraud has many negative effects, including a reduction in people’s willingness to participate in the stock market. It may also cast accountants in a negative light because they prepare and audit financial statements – sometimes even fraudulent ones. In a new study, we examine the impact of fraud on people’s willingness to join the accounting profession, which is a key input into the production of accounting information, which is the output.

We test the impact of fraud on students’ choice to major in accounting using large-scale survey data from the Higher Education Research Institute. These data enable us to conduct empirical tests with several 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 all academic majors (representing 953 universities and all 50 U.S. states), enabling us to make relative comparisons of enrollment trends in accounting versus other disciplines. Finally, fraud varies by geographical location and time and is more salient to the communities surrounding fraud firms’ headquarters. Thus, students are exogenously exposed to varying amounts of fraud during their formative high school years, which allows us to design tests with relatively strong causal identification of the effects of fraud on student self-selection into the accounting major.

To identify financial statement frauds that have the greatest potential to influence students (or influence the people who shape students’ career decisions, including parents and teachers), we focus only on frauds that were covered by the news media. We find incoming college students are actually more likely to major in accounting when local frauds occur during their high school years. As for the magnitude of this effect, we find that a one standard deviation increase in fraud exposure is associated with a 1.57 to 4.00 percent increase in the likelihood of majoring in accounting. Although this effect is modest, we view it as meaningful because it suggests that fraud does not harm the flow of students into the accounting major but rather attracts more students. Furthermore, these results are even stronger when frauds receive greater media coverage. Moreover, we find the students that enter accounting following fraud are more likely to have attributes desired by the accounting profession (e.g., high academic aptitude) and are more likely to subsequently serve in public accounting and become CPAs.

In the context of other fields (i.e., all college majors), we find that fraud spurs interest in other business disciplines but not in majors outside of business schools. Those attracted to other business disciplines, however, generally possess different traits. Students entering accounting are distinctively more likely to exhibit values espoused by the accounting profession, including a predisposition to public service. Thus, non-pecuniary motives appear to drive accounting student enrollment following fraud. Collectively, our findings suggest that, while fraud is unmistakably bad, it appears to have the positive unintended consequence of attracting labor into business disciplines and, in accounting, increasing the prevalence of desirable traits among entrants.

These findings expand our understanding of the externalities of financial statement fraud by providing initial evidence of its effect on entrants into the labor market for all business disciplines. While fraud is criminalized in part because its externalities are thought to exceed remediable civil damages, we have a limited understanding of the wider spillover effects of fraud on society. Research to date suggests that financial fraud can have damaging externalities, including contagion across peer firms, reduced trust and participation in capital markets, and increased criminal activity. While the findings from these studies might imply that fraud would create a negative stigma around the labor market for all business fields, and accounting in particular, we find the opposite.

The results of our study should be of interest to researchers and regulators considering the quality of accounting judgment and decision-making. Understanding the determinants of the individual-level characteristics of accountants is important because they are key inputs into the quality of accountants’ decisions. While experimental research demonstrates that individual differences are important drivers of performance on accounting tasks, relatively little is known about the process by which people with varying characteristics choose accounting careers. In other words, existing research is informative about the importance of individual differences for explaining performance on accounting tasks, but it is far less informative about the origins of these individual differences among accountants. Our study provides evidence that people entering the accounting profession exhibit systematic differences from workers entering other fields, and these differences are sensitive to individuals’ early exposure to fraud.

This post comes to us from Robert Carnes at the University of Florida, Dane Christensen at the University of Oregon, and Paul Madsen at the University of Florida. It is based on their recent article, “Externalities of Financial Statement Fraud on the Incoming Accounting Labor Force,” available here.