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European Journal of Social Sciences Volume 12, Number 2 (2009)

Preventing Employee Theft and Fraud

M. Krishna Moorthy Lecturer, Faculty of business and finance, Universiti tunku abdul rahman Perak campus, 31900, kampar, Perak d.r., Malaysia E-mail: A. Seetharaman Professor (Strategy), S. P. Jain center of management, Singapore 119579 E-mail: Nakha Ratnam Somasundaram Specialist, Faculty of management, Multimedia university 63100, cyberjaya, Malaysia E-mail: M. Gopalan Lecturer, faculty of management, Multimedia university, Persiaran multimedia 63100, cyberjaya, selangor darul ehsan, Malaysia E-mail: Abstract Employee theft is a large problem for firms of all sizes, particularly small businesses where profit margins are often very meager. The purpose of this paper is to examine the perceptions of fraud and employee theft and also to suggest measures detecting and preventing employee theft. In the first part it deals with identifying activities which constitute employee theft and points out the symptoms and terms that indicate possible employee theft based on the studies and the theories of social scientists. In the second part it deals with the reasons of theft by employees and some factors that should be considered to prevent employee theft. In the last part it identifies methods those work well for fraud detection and prevention, prescriptive information to rule out sliming business revenue. Employee theft is an ongoing, widespread, and varied problem for companies of all sizes. This kind of theft hinders company productivity and profitability in several ways. This includes stock replacement costs, time and diversion of resources from business activities, decreased employee morale, poor culture for productivity, and opportunity cost of missed sales. In summary, small businesses cannot operate efficiently if employees are stealing goods and management is not properly monitoring and controlling employee theft.

The Association of Certified Fraud Examiners (ACFE) estimates that the typical business will lose an average of six percent of revenues from employee theft. The ACFE Report indicates that small businesses suffer disproportionate losses because of the limited resources they have to devote to detect fraud. A U.S. Chamber of Commerce survey reported that one-third of business bankruptcies are due to employee theft. The report mentions that one of the most serious threats to the success of a small business is employee theft. Misplaced trust, lax hiring and supervision, and a failure to implement basic financial controls can lead to an environment that is ripe for internal theft and fraud. 259

European Journal of Social Sciences Volume 12, Number 2 (2009) Both large and small companies today are now placing a renewed importance on preventing theft to help improve profitability as they face a competitive economic environment and rising costs. Large companies face a high rate of embezzlement of money that siphons off large amount of revenue, whereas small businesses face sizeable amount of inventory shrinkage.

Meaning of Employee Theft

Webster's New Dictionary defines fraud as intentional deception to cause a person to give up property or some lawful right. Employee theft covers a broad spectrum of acts by all categories of personnel. Retail sales personnel, storeroom, administrative, marketing, and engineering and management personnel are all equally likely to be involved in some type of this behavior. The nature of the theft is, however, varied by the type of personnel involved. Retail theft is basically with regard to merchandising type operations such as grocery stores, discount department stores and small retail businesses. Retail theft and all other types of theft tend to be associated with various breaches of the employee and employer relationship.

Research Problem
Steal and fraud of employees affect practically every organization across many dimensions. There are many types of fraud involving different levels of management. This posed many major problems in research. There are too many known and unknown frauds in business which make difficult to classify and to identify proper solutions to avoid it. There is no decision making framework for assisting managers to choose between available solutions to prevent totally this crime. There is no single straightforward test for fraud investigation to show in every case that a fraud had been committed; and although we can detect it, we cannot avoid fraud totally as it can be committed in many ways. It is difficult to estimate in financial terms the loss to business caused by fraud as most of the time frauds are unreported or under reported.

Objectives of the research

The objectives of the research are: To identify a range of issues relating to shrinkage revenue and to summarize these issues into two categories, namely: detection fraud and prevent. To determine types of employee theft as this shrinks revenue and wastes business efforts. To profile fraud offenders and examine the characteristics of the employees who commit fraud, error and abuse. To assess the impacts of fraud in organization and to detail and assess the detection and prevention controls. To build up a decision making framework for choosing the best available and proper solution.

Scope of the Study

Fraud is a significant subject that probably became a big cancer for firms. There are numerous types of frauds that are prevalent to various functions in an organization. The scope of research focuses on employee theft that involves breaches of physical assets or tangible property. The research includes analysis of the modes of fraud in organization and, the characteristics of perpetrators and attempt to cover the development and evaluation of strategies to prevent or detect fraud.


European Journal of Social Sciences Volume 12, Number 2 (2009)

Survey of literatures
Employee theft is a major component of retail shrinkage (Birendra K. Mishra, 2006). Agreement is widespread that theft in the workplace is a serious problem (Greenberg, 2002, Weber, Kurke & Pentico, 2003). Employees steel money, time, supplies, merchandise and company property information and overcharged extra cash from the customers (Justin A. Walsh 2000). 90% of the employees engage in work place deviance. 33% of the employees actually steal money or merchandise, and employees include top level executives also. Opportunity is the key to fraud. (Joseph T.Wells, 2001). The US Chamber of Commerce estimates that US employers lose $20 billion to $40 billion a year due to employee theft. Shockingly, the US Chamber of Commerce states that 30% of all business failures are caused by employee theft, citing a report by David J Shaffer and Ronald A Schmidt (Business owner, July/August, 2006). For every dollar stolen, supermarkets need to sell at least $50 more of goods to make up the loss. In other words, for one stolen $8 steak the store needs to sell $400 more (George H Condon, 2003). Employee theft is a widespread problem in businesses today and a major source of loss for retailers (Bamfield, 2004). Compared to traditional employee theft, organized retail crime (ORC) is becoming widespread, multilayered, and intricate. (Hayes and Rogers, 2003). By 1995, retail crime losses represented approximately 20-30 percent of net retail profits (Tonglet and Bamfield, 1997). In a survey of 330 top companies, a study by KPMG Peat Marwick found that 76% of the participants revealed that fraud had occurred in their organizations within the past year, and that the majority of fraud was due to poor internal controls (KPMG Peat Marwick, 1993). Brewery Inc. found that simply banning coats and bags from inventory storage areas saved $4050,000 a year in shrinkage (Weintraub, 1998).The key to fraud prevention is to be vigilant at all times and involve all staff in prevention initiatives. When ignored or undetected, employee fraud - even on a small scale - can have devastating effects on any organization or company. (Masike Bokaba, 2005). Data from more than 30 statistical samples suggest that electronic surveillance can reduce theft by 35-75% (Glover, 1995). The employee has access to the money or property taken, frequently because of the breakdown in management controls (Hemphill and Hemphill, 1975). In terms of prevention, the study, sponsored by the nonprofit group ECR Europe, found that the most serious deterrent to workplace theft is a CCTV system. The findings are based on research by Adrian Beck of the University of Leicester in Leicester, United Kingdom. (Teresa Anderson, 2007). Employees commit fraud when a combination of the following three factors is present 1) a situational pressure (usually a financial need) 2) a perceived opportunity to commit and conceal a crime and 3) a way to rationalize the dishonest act (Albrecht, W. Steve, Wernz, Gerald W, 1993). Some employees steal for status or to cover extra expenses. (Mishara, 2006). Employees prone to engage in theft are generally young, face economic pressures, and are emotionally unstable (Hollinger & Clark, 1983). Some employees steal for status or to cover extra expenses (Mishara, 2006). Employees prone to engage in theft are generally young, face economic pressures, and are emotionally unstable (Hollinger & Clark, 1983). While the inadequacy or inequity of compensation influences employee theft through feelings of deprivation, poor internal control systems often provide employees with the opportunity to steal. Some theorists believe that most people will steal if given a chance (Hollinger & Clark, 1983). Theft opportunities exist because management allows employees access to equipment and other company assets with no controls in place or because record keeping involving cash or other assets is poorly designed and/or carried out (Martin, 1981). Opportunity remains the leading cause of employee theft. (Justin A. Walsh, 2000). The propensity for employees to steal seems to be related to the individuals need, opportunity, skills, and attitude toward committing an illegal act (Murphy, 1993). Workplace thieves who have 261

European Journal of Social Sciences Volume 12, Number 2 (2009) successfully stolen before (in either a workplace or other situation) will be more likely to do so again. (Baumol (1990). The more confident individuals feel that they can successfully exploit an opportunity; the more likely they are to take action, even to the point of overconfidence (Simon & Houghton, 2003) that leads to negative consequences. Some employees seem to steal simply for the thrill of it (Latham, 2001). Individuals involved in employee theft are likely to be involved in other deviant behaviors such as alcohol, and/or drug abuse, and/or gambling (Hollinger & Clark, 1983). Research has also found that workplace thieves are generally new, part-time, or unmarried employees (Murphy, 1993). Hollinger and Clark (1983) suggest that property deviance is more common in low-paying, low-status jobs. The changing nature of and increasing stresses within the workplace are associated with counterproductive workplace behaviors, such as theft (Greenberg, 1990). A research study of 100 retail employees found that 41 of 49 employees who confessed to theft stated that they had no feelings of guilt about their crimes (Bettencourt, 1990). Employees may have individual characteristics and attitudes that motivate them to steal, but not all workers will react to the same situation in the same way. Some will act out their impulses while others may not. (Shane & Venkataraman, 2000). The size and structure of the organization seems to be related to theft. As size increases and degree of supervision decreases, theft increases (Murphy, 1993). This seems to be related to issues of proximal situations, as discussed by Greenberg (2002), in which workers tend to steal more often in impersonal situations or where the victim is less known by the thief. There may also be a perception that the likelihood of being caught is lower in large organizations. Theft in the retail area is often related to supermarkets, chain department stores and small retail businesses. (Alstete, 2006). When perceived rewards are less than perceived effort, employees may resort to theft (Murphy, 1993). One form of mistreatment that has long been identified as a correlation of workplace theft is pay dissatisfaction or perceptions of pay inequity (Hollinger & Clark, 1983). Happy employees steal less, supermarket survey reveals (Jennifer Korolishin, 2003). Perceived unfairness of pay is an important factor contributing to higher levels of employee theft (J. Greenberg, 1990, 1993, 1996, 1998, 2002). Social scientists seem to believe that the basis for the criminal behaviors are from world outside of the work environment, but is probably from the circumstances intrinsic in the work environment itself. (Alstete, 2006). When employees perceive that justice prevails, they are likely to be satisfied with and committed to the organization (Folger & Konovsky, 1989). Ethical culture is usually defined as those aspects that stimulate ethical conduct (Trevino & Weaver, 2003). Following Collier (1995), Kaptein (1998) posits that the virtuousness of a corporation can be determined by the extent to which the organizational culture stimulates employees to act ethically and prevents them from acting unethically. Kaptein (1998) found that unethical conduct occurred when employees lacked adequate or sufficient time, budgets, equipment, information, and authority to fulfill their responsibilities. Schweitzer, Ordonez, and Douma (2004) also convincingly show in their empirical study that excessively high targets stimulate unethical behavior. Workplace theft is closely associated with feelings of mistreatment by the employer (Greenberg & Scott, 1996). Workers model their behaviors on those of their coworkers or work group members (Robinson & OLeary Kelly, 1998). Coworkers are an important factor in the reporting process (Trevino & Victor, 1992; Victor, Trevino, & Shapiro, 1993). Social learning theory (Bandura, 1986) predicts that observers who witness coworkers stealing from the organization may regard these individuals as role models and may be more likely to imitate their theft behavior (Manz & Sims, 1981). People are most likely to imitate another persons behavior when that person is similar (Bandura, 1986). Many dishonest employee problems are directly attributable to lax (or nonexistent) supervision and control. (Bandura, 1986). Both personal and employer variables are important in predicting theft rates (Lucy A McClurg and Deborah S Butler, 2006) Research shows consistently that employees who have fewer stakes in the organization are more likely to steal. This lack of commitment has been measured in various ways: turnover intentions (Frazee, 1996; Thomas, Walper, Scott, & Jones, 2001), affective organizational commitment (Sims, 2002); part time rather than fulltime (Flynn, 1995), and tenure (Sims, 2002). 262

European Journal of Social Sciences Volume 12, Number 2 (2009)

Discussion, Analysis and Finding

Fraud is easy to commit, but is difficult to prevent and detect. ACFE classified fraud into three major categories: asset misappropriations, corruption and fraudulent statements. Assets misappropriation includes the misuse or theft of assets in an organization (for example inventory fraud, payroll fraud and computer fraud). Corruption is the act that people wrongly use their power in the business transaction in order to procure some benefits for themselves or others (for example, conflicts of interest and related-party transactions). Fraudulent statements are the falsification of financial statements of an organization (for example, unrecorded liabilities). Assets misappropriation is the main reason of fraud, with more than 85 per cent of total fraud under this category. The assets that are targeted by perpetrator commonly are cash.

Conceptual Framework

Indicators of Fraud
While professional internal auditors may not be the insurers against fraud, their responsibility for due professional care requires an increasingly high level of alertness to the indicators of fraud (Vanasco, 1998). An organization should take up a proactive approach to reduce costs related to fraud; fraud prevention programs should be emphasized and not reaction to fraud already committed. The symptoms of fraud are often obvious to anyone who cares to look. These indicators may arise as a result of control established by management, tests conducted by auditors and other sources both within and outside the organization. Among some indications are: accounting anomalies, which include embezzlement, understatement of liabilities, overstatement of expenses, missing documents, alterations to documents, excessive voids or credits and duplicate payments; 263

European Journal of Social Sciences Volume 12, Number 2 (2009) Internal control symptoms, which include lack of control environment, lack of physical safeguards, lack of segregation of duties, lack of proper documents and records and inadequate accounting system; Analytical symptoms, which include transactions that occur at odd times and places with amounts that are too large or too small; Lifestyle symptoms, which show the employees' living lifestyles, are far beyond what they can afford considering the employees' financial needs, greed or pressures; Behavioral symptoms, which come from the employees' odd and recognizable behavior patterns; unusual irritability and suspiciousness; and tips and complaints from other employees that something, is wrong.

Fraud Detection
Further investigation if the indicators are present may lead to fraud detection. Fraud detection is an examination of the facts to identify the indicators of fraud sufficient to warrant recommending an investigation. In fact, there is no single test that a fraud has been committed. Most frauds involve an employee or manager of the victims' organization (Commercial Angles' Newsletter, 2001a, b, c). The most effective tools for fraud detection are internal audit review, specific investigation by management, employee notification and accidental discovery. The five-step approach suggested by Vanasco (1998) for fraud detection in an audit is as follows: Know fraud exposure in specific terms; Know exposure specific symptoms of fraud; Be alert for fraud symptoms; Incorporate into routine audit program steps that are likely to reveal fraud symptoms; and Follow through on all observed symptoms.

Fraud Investigation
Investigation consists of performing extended procedures necessary to determine whether fraud, as suggested by the indicators, has occurred. It includes gathering sufficient evidential matter about the specific details of a discovered fraud. All computer fraud investigations need to start with a plan for gathering and handling the evidence. Internal auditors, lawyers, investigators, security personnel, and other specialists from inside or outside the organizations are the parties that usually conduct or participate in fraud investigations. The investigator must be familiar with good systems administration practices and possess extensive background of skills and knowledge relevant to computer security and various concepts at work in the areas under investigation (Wright, 2000). When fraud has been detected, an organizations main concern is to identify the source of fraud and to determine whether it is an internal or an external problem. When a fraud investigation reveals irregularities, which may have an adverse impact on the financial position and results of operations, the internal auditors should inform the appropriate management and the audit committee. A suspect should not be confronted until supporting evidence has been gathered. Confrontation should be done by persons who specialize in investigating criminal activity, not by internal auditors. Investigating a case may involve covert operations, surveillance, informants, dumpster diving and sources of information (Apostolou, 2000c).


European Journal of Social Sciences Volume 12, Number 2 (2009)

The Fraud Perpetrators

Fraud perpetrators are the persons those commit fraud. What is the correlation of a perpetrator's personality with the size of losses in an organization? The perpetrators are further classified into age, gender, positions education background and the factor of collusion. First, with age, the 2002 survey from the ACFE showed that the older the perpetrator, more costly their schemes become. The losses for older employees were 27 times higher than losses caused by the younger age employees. The reason being, older employees hold more senior positions with greater access to assets. Commonly, in an organization, the majority of higher positions (managerial and above) are held by males. Findings in the survey report revealed that most fraud cases were committed by males. The losses committed by males were three times more than females, i.e., males committed more than 75 per cent of all fraud. Generally, those in higher positions in an organization tend to have higher levels of education. The ACFE report showed that those with college degree caused about 3.5 times higher losses than those with only high school diplomas. As the perpetrator's education level increased, the losses are also increased. Losses caused by age, gender and education background appeared to be correlated to the employee's position in the organization. Position effects were the strongest indicator of the size of the losses in most of the fraud cases. Collusion is an illegal collaboration activity that is very difficult to prevent and detect, especially when collusion is between managers and employees. This is because the managers are naturally counted upon as a key part of the organizations control structure. They are entrusted to identify and detect fraud through their oversight functions. When managers participate in fraud along with their employees, this serves to disrupt a major component of internal control and creates a much higher level of insecurity for the organization.

Fraud Prevention
The value of internal control is apparent in both preventing and detecting fraud as prevention is better than cure. A weak internal control creates opportunities for fraud and about half of all frauds occur in the financial area (Vanasco, 1998). Internal control system has four broad objectives; those are to safeguard assets of the firm; to ensure the accuracy and reliability of accounting records and information; to promote efficiency in the firm's operation; and to measure compliance with management's prescribed policies and procedures (Haugen and Selin, 1999). The effectiveness of internal control depends largely on management integrity. The cost of a fraud is not only a monetary loss, but it vitiates the organizations atmosphere, creates mistrust and calls for harsh measures that could have been avoided. Reviewing and improving internal control are often thought of as the primary defense against fraud and abuse. A strong system of internal control is the most effective method of fraud prevention. Prevention of fraud starts with identification of the weakness in the current systems of an organization. Next, the organization must improve those systems with new or better controls. The introduction and enforcement of controls will reduce the opportunities for fraud. The control warns potential fraudsters that management is actively monitoring the business and that in turn deters fraud (Commercial Angles' Newsletter, 2001a, b, c). As a result, an organization, which seeks to contain fraud, should strive to implement a broad range of interventions, be it technical, formal or informal. Technical interventions are controls implemented to limit access to building, rooms or computer systems. Formal interventions involve horizontal expansion of the hierarchy of organization to have a flatter pyramid. Education, training and awareness programmers are some measures implemented in the informal interventions. Fraud prevention procedures should have three realistic and measurable goals: Reduce losses resulting from fraud; Deter fraud through proactive policies; and Increase the likelihood of early fraud detection. 265

European Journal of Social Sciences Volume 12, Number 2 (2009) Fraud control policies should provide guidelines on ways to reduce the risk of fraud. For example, a comprehensive security program assists in the prevention and detection of computer fraud from all sources. The use of various layers of properly implemented protection mechanisms will have the synergistic effect of increasing and enhancing a security program. Currently, many experts considered the onion model of security as the best and safest approach to manage the risks dealing with computer fraud (KPMG, 2001).

Fraud Deterrent
The deterrent effects of criminal prosecution and punishment represent the final means of preventing fraud. In addition to conventional judicial punishments such as imprisonment and fines, deterrence can also be achieved through professional disciplinary sanctions, civil action, injunctive orders and confiscation of an offender's assets. Technology would also help to deter fraud. Logic bombs is a strategy that is developed to prevent software piracy and is installed into programs. When activated through an act of unauthorized copying, the malicious code destroys the copied data and is even able to damage other software or hardware being used by the offender. Employees who cause such damage would, presumably, be personally liable for replacement costs and any consequential loss (Smith, 1999).

The computer has incredible speed. It controls one millionth of a second. Human ingenuity has always an edge over all these developments. This research only touches on the surface of the Computer accounting fraud due to time constraint. There is much more to investigate and explore on this topic especially on the techniques of committing fraud in a computerized business environment. In addition, there are still many ways of conducting investigation, as the research done in the literature review topics is quite specific. Tools for preventing and deterring fraud are not discussed in details. The legal cases and proceedings in court involving fraud are not discussed. The benefits derived from safeguarding assets through good internal control system in an organization are emphasized in the current study. An evaluation on the effectiveness of procedures and measures in preventing fraud can be a focus for further research. With the introduction of virtual business transactions in the electronic era, the risk of fraud increases tremendously. Future research can concentrate on the preventive and detective techniques as there is not much survey evidence.

Employees surveyed in this study offer advice to prevent employee theft that is largely supported by previous research, yet strongly recommends implementation or greater usage of specific measures such as video surveillance, better controls and improved record keeping. From this knowledge, managers can be reassured that continued progresses with the current trends in employee theft prevention are needed and should continue to be implemented in small businesses. Further research is needed to gauge the accuracy of these findings, especially considering the relatively small number of participants and the dispersion of their job positions in the various firms. A broader sample is needed that explores the true depth of the employee perceptions regarding the views uncovered here, especially in light of heightened global security, rising crime rates, terrorism, and technology-related crime. Variables to be potentially controlled for in a broader study may include company size, industry type, employee demographics, organizational location, and previous security concerns. If further and future studies continue to yield results such as those found in this study, then there may be additional justification for implementing additional surveillance and better internal control systems at companies. 266

European Journal of Social Sciences Volume 12, Number 2 (2009) Employee theft is an ongoing, widespread, and varied problem for companies of all sizes. This kind of theft hinders company productivity and profitability in several ways. This includes stock replacement costs, time and diversion of resources from business activities, decreased employee morale, poor culture for productivity, and opportunity cost of missed sales. In summary, small businesses cannot operate efficiently if employees are stealing goods and management is not properly monitoring and controlling employee theft. The employees surveyed in this study recommend that greater surveillance and managerial diligence in control of the operations is needed to decrease employee theft.

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