Could a more diverse environment be key to curbing accounting manipulation?
Writing: Gaia Melloni
Accounting manipulation erodes public trust in businesses, undermines the credibility of financial markets, and can ultimately destabilize entire economies. High-profile corporate scandals – from Enron and WorldCom in the US to Carillion, Patisserie Valerie, and Tesco in the United Kingdom – have shown how the misrepresentation of accounting numbers can create a dangerously distorted picture of a company’s financial health.
Through fraudulent bookkeeping, firms have concealed losses, inflated revenues and masked growing debts, misleading investors, regulators and the public. When these deceptions come to light, the fallout can be disastrous: shareholders lose billions, employees face redundancies and pension shortfalls, and public trust in corporate governance is deeply shaken.
Such cases raise important questions. What prompts companies to manipulate their accounts, and what kinds of environments make this behavior more or less likely in the first place? Understanding these wider influences is crucial if we want to prevent such misconduct, rather than simply respond to it.
Business in the community
Alongside colleagues Jafar Al Saleem (SUNY Empire State University), Ricardo Malagueño (Essex Business School) and Ana Marques (Norwich Business School), we set out to explore how a company’s surrounding environment might shape its likelihood of engaging in accounting misbehavior, particularly earnings management. Rather than focusing solely on internal corporate governance or individual leadership traits – topics that have already been widely studied – we asked whether the social composition of the community in which a company operates could play a role.
To investigate this, we examined whether firms located in areas with higher levels of population diversity displayed different patterns of accounting manipulation than those based in more socially homogeneous regions. We measured this across four aspects of social identity: race, religion, age and gender. The core idea is straightforward yet compelling. Communities composed of individuals from varied racial, religious, age and gender backgrounds expose firms to a richer array of viewpoints and expectations. Might this broader and more heterogeneous oversight naturally discourage dubious accounting behavior?
The answer is presented in our study (which was recently published in the Journal of Accounting, Auditing & Finance) where we analyzed almost 13,000 US firm-year observations covering the period 2000-2016. Drawing on US census data and the Association of Religion Data Archives, we created indicators of racial, religious, age and gender diversity, and compared them with measures of earnings management such as discretionary accruals, revenue manipulation, and current accruals. We employed advanced econometric methods to isolate the effect of community diversity and validate the robustness of the analyses.
Our results consistently revealed a statistically significant relationship lending support to our hypothesis: firms located in more diverse communities were less likely to engage in accounting manipulation. Across all four of the dimensions that we examined, higher diversity in a company’s surrounding environment was associated with lower levels of earnings management. Importantly, this relationship held even after we controlled for a broad set of firm-level characteristics, including size, profitability, leverage, industry and governance structure. In other words, the effect of local diversity cannot be explained simply by firms being larger, better resourced or members of particular industry groups; it appears to reflect the social norms and expectations embedded in the communities where firms are headquartered.
We also found that internal leadership characteristics matter. Firms led by female CEOs, or those with executives receiving higher remuneration, were notably less likely to manipulate their accounts. This indicates that both external social environments and internal governance cultures play reinforcing roles in shaping ethical behavior.
Taken together, these patterns suggest that community diversity may serve as a predictor of financial corporate misconduct, by shaping the norms of accountability and fairness that underpin and inform corporate decision-making in meaningful ways.
Ethics shaped beyond the office walls
Our findings expand the discussion on diversity beyond boardrooms and internal hiring policies. They indicate that the social environment surrounding a company is important. The daily interactions, norms and expectations within more diverse communities seem to influence decision-making inside firms, promoting transparency and reducing manipulative behavior.
In other words, diversity in the broader environment is not just a background condition. It can serve as a structural safeguard for financial honesty, affecting how executives assess risks, ethical boundaries, and their responsibilities
to stakeholders.
Businesses do not operate in isolation; they are deeply embedded in local communities whose social makeup can influence corporate behavior. When set in diverse communities, companies are exposed to a broader range of perspectives, moral standards and societal expectations. This heterogeneity creates a more complex form of scrutiny, which firms cannot easily ignore.
Fostering inclusive and diverse communities can promote integrity within organizations. People from different backgrounds – whether in terms of religion, race, age, gender or lived experience – tend to bring distinct perspectives, questions and ethical reference points to the table.
This diversity of outlook makes it harder for groupthink to develop, provides unique perspectives for analyzing problems and asking questions, improves decision-making, and discourages unethical behavior.
Amid political debates in many countries that question the value of diversity, our findings provide a timely counterpoint: inclusiveness is not a weakness, but a strength. Far from damaging cohesion, diversity seems to enhance it, helping organizations build trust, fairness and long-term stability. By offering an extra safeguard against corporate misconduct, diverse environments benefit not only investors and boards, but also employees, consumers, and society as a whole.
Diversity is not just a social ideal – it is a practical asset in preserving the integrity of our economic and governance systems.
Gaia Melloni is an associate professor in the Department of Accounting and Control at HEC Lausanne, University of Lausanne
