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The Control Fraud Theory | Bizcovering
Control fraud theory poses a fundamental challenge to the core models of finance and economics. The efficient markets (and contracts) hypothesis requires that markets be able to identify and exclude control frauds, and the dominant law and economics model asserts that they do so effectively and quickly. This claim is largely premised on the view that no top-tier audit firm would give a clean opinion to a control fraud. Control frauds have consistently falsified this claim. Deposit insurance was not the key to S&L control fraud. Control frauds deceive "creditors at risk." High reported profits allow them to grow rapidly by borrowing and issuing stock.
This also will not be learned as "the core models of finance and economics" appear to have come out of the crisis unscathed, at least as far as the core community of financiers and economists is concerned.

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Mon Apr 25th, 2011 at 04:45:42 AM EST
Schneier on Security: Control Fraud quoting a PDF by William K. Black.
White-collar criminology findings falsify several neo-classical economic theories. This paper discusses the predictive failures of the efficient markets hypothesis, the efficient contracts hypothesis and the law & economics theory of corporate law. The paper argues that neo-classical economists' reliance on these flawed models leads them to recommend policies that optimize a criminogenic environment for control fraud. Fortunately, these policies are not routinely adopted in full. When they are, they produce recurrent crises because they eviscerate the institutions and mores vital to make markets and governments more efficient in preventing waves of control fraud. Criminological theories have demonstrated superior predictive and explanatory behavior with regard to perverse economic behavior. This paper discusses two realms of perverse behavior the role of waves of control fraud in producing economic crises and the role that endemic control fraud plays in producing economic stagnation.


Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Mon Apr 25th, 2011 at 05:03:09 AM EST
[ Parent ]
are the "professional services" firms - they need to be broken up so that accounting services and consultancy services (ie tax or accounting "optimisation," also known as regulatory arbitrage)  cannot be provided by the same entities - at all.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Apr 25th, 2011 at 05:23:49 AM EST
[ Parent ]
Breaking them down reduces their political power, but it also increases the amount of resources needed to police their behaviour since you need more inspectors to supervise more firms, even if the total amount of business done by all the firms in the sector stays constant.

And that would be in itself criminogenic: Schneier on Security: Control Fraud

"Systems capacity" theory examines why under deterrence is so common. It shows that, particularly with respect to elite crimes, anti-fraud resources and willpower are commonly so limited that "crime pays." When systems capacity limitations are severe a "criminogenic environment" arises and crime increases. When a criminogenic environment for control fraud occurs it can produce a wave of control fraud.

"Neutralization" theory explores how criminals neutralize moral and social barriers that reduce crime by constraining our decision-making to honest enterprises. The easier individuals are able to neutralize such social restraints, the greater the incidence of crime.

I do think this explains why VAT evasion is so prevalent among small businesses in Spain.

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Mon Apr 25th, 2011 at 05:38:28 AM EST
[ Parent ]
But you don't need to police the mercenary accountants who construct tax shelters, as long as you police the auditors who sign off on the cash flow statement. Then you can work from first principles based on the cash flow. Any disagreement may be resolved by telling the firm that their tax lawyers are too aggressive. And that if they persist in their disagreement, they are welcome to a highly public court case that will splash their effective tax rate all over the front pages.

But this requires a truthful and reasonably accurate picture of the cash flow, which is why you have to police the auditors that audit the cash flow statements.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 25th, 2011 at 07:05:55 AM EST
[ Parent ]
But cash flow in cash, without invoices, is almost by definition impossible to audit.

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Mon Apr 25th, 2011 at 07:15:05 AM EST
[ Parent ]
Ah, yes, but if you have a reasonably sizeable VAT, then people have an incentive to keep a paper trail. Otherwise, they might find that the VAT that other people have invoiced as having paid to them exceeds their own markup. Which would be bad for the continued viability of their business as a going concern.

Besides, you can't borrow against future cash flow without paper trails. So large and medium-sized firms have an incentive to keep an audit-able paper trail. Particularly if you audit the banks to make sure that the money they issue is backed by an auditable future cash flow.

Small business have cashflows in cash. But small businesses don't do control fraud or aggressive accounting. They do conventional man-with-suitcase fraud, or simply don't disclose their incomes.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 25th, 2011 at 12:03:18 PM EST
[ Parent ]
I do think this explains why VAT evasion is so prevalent among small businesses in Spain.

A sole proprietorship or family business is a control fraud waiting to happen. If one person can control what information gets passed to all others there is not even a requirement for a conspiracy. As one successful small businessman who grossed over $10 million a year once told a friend: "Sometimes I just have to close the door and do things that I never tell anyone else about."


"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Apr 26th, 2011 at 12:42:09 AM EST
[ Parent ]
ARGeezer:
A sole proprietorship or family business is a control fraud waiting to happen.
And, so, in countries with large informal sectors or underground economies, where enforcement is lax or resource-poor, a criminogenic environment is created in which you're considered stupid if you don't steal from your employees, providers, customers and the taxman.

I have lately thought that, if ordinary small businesses are control frauds where poor performance and graft by the owners are normal, it cannot be too hard to run a business profitably. If you don't steal from your own business it should be easier to keep it running.

Economics is politics by other means

by Carrie (migeru at eurotrib dot com) on Tue Apr 26th, 2011 at 05:27:31 AM EST
[ Parent ]
But they don't steal from their business. They steal from everybody else's business. That's sorta the point.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 26th, 2011 at 07:48:28 AM EST
[ Parent ]
See ARGeezer's comment. That's sorta the point.

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Tue Apr 26th, 2011 at 10:40:38 AM EST
[ Parent ]
When the contracting company for which I worked more than 17 years was contemplating turning itself into an Employee Stock Ownership Plan company I was discussing the negative attitudes of some of my fellow employees with the ESOP advisor. The problem was that the four partners were seen as having appropriated company property for personal use. All four had extensively and expensively remodeled their homes and things such as new electrical service panels had gone through the warehouse even though we did not use such products on any of our jobs. I just figured that that was something that would stop after ESOP conversion, but others were more skeptical. The advisor told me: "The owners of small companies always look on the company as their personal piggy bank." In this case all four were expected to only loot about the same amount each.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Apr 26th, 2011 at 10:38:20 AM EST
[ Parent ]
Possible to state {some/most} small business owners see the business as an extension of their ego?

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Tue Apr 26th, 2011 at 12:11:54 PM EST
[ Parent ]
I've worked in two closely held firms definitely more in the Medium than Small Enterprise category, but still it was apparent that their internal functioning strongly reflected the personality of the owner/managers.

Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Tue Apr 26th, 2011 at 12:16:45 PM EST
[ Parent ]
That's my experience as well.  However, spit in one hand, hold anecdotal evidence in the other, and decide which is "more real."

IF it is accurate we've got a fact of no mean importance.


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Apr 26th, 2011 at 12:33:39 PM EST
[ Parent ]
"fact" s/b "insight"

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Tue Apr 26th, 2011 at 12:34:31 PM EST
[ Parent ]
Recommended viewing: Gordon Ramsey's Kitchen Nightmares.

Ramsey travels the US and helps restaurants on the brink of bankrupcy. 9 out of 10 times the problems are well known to the staff but the owner is to stubborn to listen.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Apr 27th, 2011 at 03:42:07 AM EST
[ Parent ]
A swedish kind of death:
Ramsey travels the USmostly England and helps restaurants on the brink of bankrupcy


Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Wed Apr 27th, 2011 at 04:19:27 AM EST
[ Parent ]
Either it tells you what you need to know about my observations of what goes on at the telly, or Swedish tv chooses the american episodes on purpose. After all Amazing race is marketed at swedish tv as "see americans who could not find Europe on a map of Europe make fools of themselves" and considering the number of seasons they have shown, I guess that is a succesfull strategy.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
by A swedish kind of death on Wed Apr 27th, 2011 at 05:58:50 AM EST
[ Parent ]
Oh, right: Kitchen Nightmares - Wikipedia, the free encyclopedia
Kitchen Nightmares is an American reality television series on the Fox network, in which Chef Gordon Ramsay spends a week with a failing restaurant in an attempt to revive the business.[1] It is based on the British show Ramsay's Kitchen Nightmares.


Economics is politics by other means
by Carrie (migeru at eurotrib dot com) on Wed Apr 27th, 2011 at 06:00:19 AM EST
[ Parent ]
They tend to see it as something they own*. Explaining the practical difference between "the company's property" and "your property" can be fun. In fact, the person being looted from is the tax man, who generally has a hard time hunting down that sort of income for taxation purposes.

* Which they do.

by Colman (colman at eurotrib.com) on Tue Apr 26th, 2011 at 01:35:13 PM EST
[ Parent ]

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