The Influence of Unrelated and Related Diversification on Fraudulent Reporting

This study suggests that unrelated diversification has a positive influence on the probability of fraudulent reporting whereas related diversification has a negative influence on the probability of fraudulent reporting. The strength of the influence of these corporate level strategies is contingent on the moral character of the firm. Unrelated diversification provides opportunity for financial innovation within the firm’s internal capital market, which can result in fraudulent reporting. This is more likely when the moral character of the firm is driven by a conscienceless financial self-interest motive, as implied by the firm’s contempt toward the larger community (in terms of damage inflicted on the interests of people outside the firm). In contrast, related diversification, where product divisions focus on mutual sharing and monitoring of operational activities, can reduce the probability of fraudulent reporting. This is more likely when constituents within the firm view themselves as moral citizens, as implied by the firm’s benevolence toward the larger community. Hence, while unrelated diversification focuses the energies of managers within the firm on financial manipulation, related diversification focuses these energies on productive purposes.