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MAJ
23,2 Quality of internal control
procedures
Antecedents and moderating effect on
104 organisational justice and employee fraud
Kirsty Rae and Nava Subramaniam
Department of Accounting, Finance and Economics,
Griffith University, Southport, Australia

Abstract
Purpose – This study aims to bring together theoretical concepts from the organizational justice,
internal control and fraud literature to develop two distinct models relating to employee fraud and the
quality of internal control procedures (ICP), respectively.
Design/methodology/approach – Survey data from 64 Australian firms were used to develop the
two models. The first model was tested using a logistic regression analysis, and the second model was
tested using a multiple regression analysis.
Findings – The first model reveals that the quality of ICP has a moderating effect on the relationship
between perceptions of organizational justice and employee fraud. The second model indicates that ICP
quality is significantly and positively related to three key organizational factors: the corporate ethical
environment, the extent of risk management training of staff, and the internal audit (IA) activity level.
Practical implications – Risk management strategies relating to employee fraud will need to pay
greater attention to organizational factors that affect both perceptions of justice at the workplace and
ICP quality, including fostering a more ethical and equitable work environment, increasing IA
activities and staff training in risk management.
Originality/value – Using the fraud triangle framework, this study extends previous literature by
providing empirical evidence on the role of organizational justice and ICP regarding employee fraud.
Keywords Fraud, Ethics, Employees, Auditing
Paper type Research paper

Managerial Auditing Journal
Vol. 23 No. 2, 2008
pp. 104-124
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900810839820
Introduction
Failure to prevent and detect fraud has serious consequences for organizations. In the
USA, it is estimated that the financial costs associated with employee fraud is around
US$50 billion annually (Coffin, 2003). A recent survey in the UK indicates that the cost of
employee fraud to listed companies alone amounts to some £2 billion a year (Management
Issues News, 2005). In 2004, an Australian and New Zealand KPMG study of 491 large
businesses showed that 27,657 incidents of fraud occurred in the two years from April
2002 to March 2004, with total losses amounting to A$456.7 million (KPMG Forensic,
2004). The study also revealed a diverse set of fraudulent activities including financial
statement fraud, misappropriation of assets, information theft and receipt of kickbacks or
bribery. Further, the major perpetrators of fraud were found to be employees, and almost
67 per cent of such fraud was committed by those at management level.
Management control system features such as internal control is commonly regarded
as a key deterrent of fraud. According to the Committee of Sponsoring Organizations
(COSO, 2004), internal control is:
 . . . a process, effected by an entity’s board of directors, management and other personnel, Quality of
designed to provide reasonable assurance regarding the achievement of objectives in (1) the
effectiveness and efficiency of operations, (2) the reliability of financial reporting, and (3) the internal control
compliance of applicable laws and regulations[1]. procedures
Thus, a system of internal controls potentially prevents errors and fraud through
monitoring and enhancing organizational and financial reporting processes as well as
ensuring compliance with pertinent laws and regulations. 105
The objectives of the present study are two-fold. The first objective is to examine
whether the quality of internal control procedures (ICP) has a moderating effect on the
relationship between perceptions of organizational justice and employee fraud. By
linking Albrecht et al.’s (1984) “fraud triangle” framework with the organizational
justice and internal control literature (Homans, 1982; Moorman, 1991; Holtfreter, 2004;
COSO, 2004), we propose an integrated model whereby organizational justice
perceptions (OJP) are viewed as being related to the incentive and the rationalisation
motivations for fraudulent behaviour and ICP quality as a proxy for opportunities to
commit fraud. Following Moorman (1991, p. 845), organizational justice is “the term
used to describe the role of fairness as it directly relates to the workplace” while ICP
quality refers to both the design of the internal control policies and procedures within
the organization as well as the extent of adherence to such policies and procedures by
employees (Marshall, 1995). The second objective of the study is to assess the
relationship between the quality of ICP and three organizational factors; namely,
corporate ethical environment, internal audit (IA) activities and the existence of risk
management training (RMT). The selection of the three organizational factors is based
on the COSO internal control system framework, whereby the organization’s internal
environment, its risk assessment policies and monitoring activities are seen to be
distinct elements of a larger system of management controls that are related to ICP
quality (COSO, 2004).

Motivation for the study

As shown in Figure 1, Albrecht et al. (1984) propose that fraud occurs when there is:
(1) incentive to commit fraud;
(2) rationalisation for justifying fraudulent behaviour; and
(3) opportunity to commit fraud.

Opportunity

Fraud Triangle

Pressure Rationalization
Figure 1.
Source: Reprinted from "Occupational Fraud and Abuse," by The fraud triangle
Joseph T. Wells, Obsidian Publishing Co. 1997
MAJ These three situational factors are collectively known as the “fraud triangle”. The
23,2 factor termed pressure (also referred as incentive) relates to employees’s motivation to
commit fraud as a result of greed or personal financial pressure amongst a variety of
reasons, while rationalisation denotes justification of fraudulent behaviour as a
consequence of an employee’s lack of personal integrity, or other moral reasoning. The
third factor, opportunity, refers to a weakness in the system where the employee has
106 the power or ability to exploit, making fraud possible.
Extant empirical evidence linking each of the three situational factors with the
incidence of fraud, however, is largely anecdotal, often based on case study
observations, which in turn limits the generalizability of previous findings (Guercio
et al., 1988; KPMG Forensic, 2004). Further, the fraud triangle also suggests that the
incidence of fraud is likely to be complex and a function of a combination of factors.
For example, Baker (1990) argues that in some cases although internal controls were
poor, there was no incidence of fraud, while in other cases even when good internal
controls had existed, employees managed to circumvent the internal controls to commit
fraud. It is further argued that both the opportunity and the motivation to commit
fraud are key factors influencing fraud incidence, and thus an organization is likely to
be more vulnerable to fraud when both conditions exist concurrently, rather than
individually. However, no study to date has undertaken a systematic analysis of
the interactive effects of the various situational factors on employee fraud. Such
evidence is critical for developing a richer understanding of the effects of different
combinations of situational factors on employee fraud, which subsequently will lead to
the development of more effective management control strategies for the detection and
prevention of fraud.
A further motivation is that internal control has in recent years gained significant
attention as a key corporate governance mechanism. The recent mandate by the
Sarbanes-Oxley Act (2002) in the USA that management produce a report on the
adequacy of the organization’s internal control structure, and that such report be audited
by external auditors, signals the increased reliance placed on internal controls as a
critical internal monitoring process. Previous studies on internal control have been
largely descriptive (Meiners, 2005; Leinicke et al., 2005; Geller, 1991), with little attention
placed on how different aspects of a system of internal controls affect each other. In
particular, employee adherence to the set ICP, e.g. policies on approvals, authorisations,
verifications, reconciliations and segregation of duties need to be both well designed and
to be strictly followed by employees. No doubt, having strong ICP across all units or
areas of a firm improves the chances for errors and fraud to be detected and prevented.
Yet, there is limited evidence on the factors that affect the quality of ICPs. The auditing
standards on internal controls (ISA400; ASA 400) clearly distinguish the control
environment which represents management’s overall attitude, awareness and actions
regarding internal controls from the control procedures which are the detailed set of
guidelines and procedures that management establishes over information and
transaction processing. It is also argued that various control environment features
such as management’s tone (otherwise referred to as “tone at the top”), and the quality of
monitoring activities may affect how well individual employees adhere to internal
control policies and procedures (Tipgos, 2002). Unfortunately, there is scant empirical
evidence on how the internal control environment and related organizational factors
may affect ICP quality. Such evidence is important as it will provide a more
comprehensive understanding of the quality of the inter-relationships between the Quality of
various components of an internal control system, leading to more cost-effective internal control
management of an entity’s overall internal control system.
The remainder of the paper is structured as follows. First, we develop two distinct procedures
models for study, the first on employee fraud and the second on ICP quality, which lead
to the proposal of four separate hypotheses. Next, the research method is delineated,
followed by the results and a discussion of the findings. The final section of the paper 107
provides the conclusions and limitations of the study.

Hypotheses development
Organizational justice
In this study, we argue that perceptions of organizational justice are linked with an
individual’s rationalisation and motivation to commit fraud. The concept of
organizational justice is a psychological concept that is “concerned with the ways in
which employees determine if they have been treated fairly in their jobs and the ways
in which those determinations influence other work-related variables” (Moorman, 1991,
p. 845). Based on equity and justice theories (Organ and Moorman, 1993; Konovsky and
Pugh, 1994), the organizational justice concept can be further understood to
encapsulate two sub-dimensions: distributive and procedural justice. Distributive
justice is a psychological concept that relates to the perceived fairness of outcomes,
while procedural justice refers to the extent to which a decision-making process is
perceived to be fair (Posthuma, 2003; Dietz et al., 2003). Both dimensions are linked by
the concept of fairness and have implications for employees’s behaviour as a result of
their perceptions of equitable treatment. Prior studies in general have found that when
organizational justice is perceived as being low, it is likely to create dissatisfaction,
resentment and even anger against the organization (Homans, 1982; Bies and Moag,
1986). Consequently, such attitudes are seen to motivate various types of workplace
deviant behaviour which include behaviours that are directed at organizations (such as
tardiness, absenteeism, theft and sabotage) as well as those directed at individuals in
the workplace (such as intimidation, ridicule or abuse towards others) (Henle, 2005).
Dietz et al. (2003), argue that employees tend to view repeated instances of unfair
treatment at work as being a sign of disrespect for the individuals, creating feelings of
animosity which in turn could escalate into a shared sense of negativity towards the
organization, leading to workplace deviance. For instance, the empirical findings by
Giacalone et al. (1997) indicated that low-distributive justice perceptions were
significantly associated with instances of sabotage, and low-procedural justice
perceptions were found by Bies et al. (1997) and Goldman (2003), to be significantly
associated with revenge and consideration of litigation.
In this study, we argue that poor perceptions of organizational justice are likely to
increase the pressure or motivate an employee to retaliate through employee fraud.
Further, when perceptions of organizational justice are low, employees are more easily
able to rationalise committing theft because they are more likely to feel vindictive
against an “unjust” employer and experience less guilt in doing so. Empirical findings
by Greenberg (1993) support a significant and negative correlation between
perceptions of organizational justice and fraudulent behaviour. Based on an
experimental study of 102 undergraduate students, Greenberg (1993) found that
MAJ equitably paid subjects took precisely the amounts that they were entitled to take,
23,2 while underpaid subjects took more than they were permitted.
However, findings by Skarlicki et al. (1999) and Henle (2005) indicate that the
relationship between perceptions of organizational justice and workplace deviance
may be moderated by other factors. For example, Skarlicki et al.’s (1999) study
examined personality factors as a moderating factor on the link between OJP and
108 workplace retaliation, e.g. “taking supplies home without permission” and “damaging
equipment or work processes on purpose”. The results indicate that as OJP improved,
the degree of workplace retaliation decreased, particularly in situations when employee
personality factors such as “positive affect” and “agreeableness” were high.
Likewise, Henle (2005) found personality constructs of “socialisation” and “impulsivity”
had a significant moderating effect on the relationship between organizational justice and
workplace deviant behaviours such as “taking property from work without permission”.
In this study, we argue that the opportunity to commit fraud has a moderating effect
on the relationship between OJP and the incidence of employee fraud. We propose that
ICP quality acts as a proxy measure for the opportunities for fraud to occur because
high-quality ICPs act to minimize the frequency and severity of frauds, whereas
poor-quality ICPs are likely to increase the opportunities for fraud. Please refer
Figure 2.

The moderating role of ICP quality

Numerous anecdotal evidence indicate that ICPs are an important element in
preventing and detecting fraud. For example, Peterson and Gibson (2003) detail a case
where poor ICP procedures relating to a lack of segregation of duties and absence of an
independent reconciliation of cash and poor documentation were seen as factors that
enabled fraud to occur. For instance, the senior cashier who was caught embezzling
was found to have responsibility over both the recording and the custody of cash.
Similarly, other studies also demonstrate that the absence of segregation of duties by
combining incompatible roles and control breakdowns have been instrumental in
enabling fraud to be committed (Buckhoff, 2002; MacArthur et al., 2004).
For this study, based on the preceding discussions, it is argued that employee fraud
is most likely to occur in situations when both the motivation to act dysfunctionally (as
a result of low perceptions of organizational justice) arises, and the opportunity to
commit fraud due to poor internal controls exist concurrently, rather than when only
one or neither situation exists. In other words, in situations when organizational justice
is perceived as being poor, the propensity for employees to act dysfunctionally in terms
of committing fraud is likely to be high, and if ICP quality is also poor in such
situations, then the opportunities for an employee to commit fraud will increase. As
noted by Moorman et al. (1998), perceptions of poor procedural justice have a negative

ICP
quality

Figure 2.
Model 1 – the interaction Organizational Incidence of
effect of OJP and ICP justice employee fraud
quality on employee fraud perceptions
impact on organizational citizenship behaviour because the perception of injustice Quality of
affects the degree to which an employee believes an organization values him or her. internal control
Inadequate ICP, such as a lack of segregation of duties or poor transaction processing
procedures, will further increase the risk of employees being able to easily defraud the procedures
company. By contrast, when OJP are high and ICP quality is high, then both the
motivation and the opportunity to defraud an organization are likely to be low.
Consequently, the incidence of employee fraud will be low in such situations. 109
In sum, we expect the relationship between employee perceptions of organizational
justice and incidence of employee fraud to be moderated by quality of ICP. Thus, the
first hypothesis of the study is as follows:
H1. There is a significant interaction between the employee perceptions of
organizational justice and ICP quality affecting the incidence of employee fraud.

Antecedents of ICP quality

In this section, we predict three separate hypotheses between the quality of ICP and the
following independent variables:
(1) corporate ethical environment;
(2) RMT; and
(3) IA activities of an organization.

Figure 3 shows the overall conceptual model.

Corporate ethical environment

While ICP can be easily written down as formal organizational policies, getting
individuals or employees to adhere to such policies is more difficult. Carelessness, laziness
and even disobedience are sometimes considered plausible reasons for ignoring ICP.
However, we argue that in a more ethical environment, employees will tend to follow
company rules and regulations because it would be the morally acceptable behaviour.
According to COSO (2004), the ethical environment of an organization encompasses
aspects of upper management’s tone in achieving organizational objectives, their value
judgments and management styles. Victor and Cullen (1987), who introduced the concept
of ethical climate as a framework to explain and predict ethical behaviour in organizations,
propose that morally acceptable behaviours based on honesty, integrity and self-discipline

Corporate ethical
environment

Risk management ICP

training quality

Figure 3.
Model 2 – determinants of
Internal audit activities ICP quality
MAJ are promoted actively in organizations with highly ethical environments. Ethical values
23,2 may be communicated by example through leadership, and management’s strict
adherence to admonishing those who violate the ethical standards or code. Therefore, it is
expected that employees in organizations with high standards of integrity and ethics are
more likely to adopt and enforce high-quality ICP.
Valentine et al. (2002), for example, based on a sample of 304 young working adults
110 found that the corporate ethical environment was positively and significantly associated
with the organizational commitment of employees. Organizational commitment
generally refers to employees’s attitudes and feelings of being connected with
the company’s values and way of doing things (Schwepker, 1999). It is argued that in a
more ethical corporate environment, employees will be more willing and committed to
adhere to the set rules and regulations within an organization. Kizirian and Leese (2004),
in a recent study of the audit papers of 60 information systems audit engagements, found
that the client’s “management tone” particularly in terms of their attitudes towards
security consciousness, has a significant effect on the strength of the client’s security
controls. The results further indicate that management’s attitude towards the promotion
of an environment where the validity and integrity of security policies are emphasised
was a strong predictor of the security control strength. Likewise, in this study we expect
that the higher the ethical stance of management, the more favourable will employees’s
attitudes towards adhering to proper rules and procedures including the ICP be.
Therefore, based on the above discussion, the second hypothesis of the study is as
follows:
H2. There is a positive relationship between the organization’s ethical
environment and ICP quality.

Risk management training

Enterprise risk management is a process designed to identify potential events that may
affect the entity, and to manage risks within the entity’s risk appetite so as to provide
reasonable assurance regarding the achievement of entity objectives (COSO, 2004). Risk
management and internal control are an integral part of a firm’s central business
activities, which are conducted to achieve its strategic business objectives (Spira and
Page, 2003). Therefore, it is expected that when managers are more aware of the various
business risks facing their organization, they are more likely to ensure that RMT is
actively undertaken for staff members, and this is expected to lead to improved ICP
quality. Farrugia (2002) asserts that staff training is a key element in risk management
and one that needs constant reappraisal with regard to the type of risk and design of
controls as organizations operate in a dynamic environment. In this study, we argue that
employees who are actively trained in risk management are likely to more accurately
identify threats to the organization as a result of weak or non-existent internal controls
(Kramer, 2003). Further, with RMT, staffs are also likely to appreciate the linkages of
risks across different sections of the firm and the implications of internal control
breakdowns from a firm-wide perspective. Consequently, such staff may be expected to
not only develop a more compliant attitude to following set rules and procedures, but
also may even suggest viable improvements to procedures, which will ultimately
improve ICP quality.
Thus, we argue that with increasing levels of RMT, employees’s overall
understanding of the importance and benefits of adhering to ICP can be improved
and subsequently, the overall ICP quality of the firm can be enhanced as well. Based on Quality of
the preceding discussion, the third hypothesis is as follows: internal control
H3. There is a positive relationship between the extent of RMT and ICP quality. procedures
Internal audit activities
Traditionally, the IA functions to assess the effectiveness of the organization’s internal
controls and to report to management where and how internal controls could be
111
strengthened. Besides, auditing financial transactions, IA activities may also cover
non-financial areas such as business unit processes, geographical areas and compliance
with laws and regulations. Perry and Bryan (1997) argue that the IA plays a crucial
role in the prevention and detection of fraud within an organization by ensuring that
the audit is well planned and that a proper IA programme exists. Having a broad scope
of audit operations and activities in particular is seen as vital for identifying areas
where the controls are not fully functioning and procedures are unclear. Likewise,
McNamee and McNamee (1995) in their characterisation of the history of internal
auditing, note that IAs have become a primary agent for transformational change in
helping users of systems improve the design of their controls.
Moyes and Baker (1995) found that the enhanced use of appropriate audit techniques
helps identify weak internal controls and subsequently, minimize fraud. Case study
observations by Peterson and Gibson (2003) found that IAs’ recommendations for
improving ICP are critical for not only preventing control breakdowns but also for
detecting fraud as well. In this study, it is argued that the more extensive an IA function
(i.e. the larger the number of audit activities), the greater the likelihood that weaknesses
in ICP are identified. Consequently, through better identification of ICP weaknesses,
appropriate remedial measures may then be undertaken, leading to a higher quality ICP.
Therefore, the fourth and final hypothesis is as follows:
H4. There is a positive relationship between the extent of IA activities and ICP
quality.

Research method
Sample
The sample population involved firms from a cross-section of industries including
manufacturing, retail, automotive dealerships, information technology, wineries and
hotels. The database was developed from two sources. The first data set accessed the
Business Review Weekly list of 1,000 largest Australian firms as at 30 September 2003
(www.brw.com.au). About 160 firms whose revenues ranged from $20 to 110 million
per annum were selected randomly from the database with the aim of accessing
medium- to large-sized firms. The second data set comprises 160 four and five star
hotels in Australian capital cities derived from the Dawson’s (2003) hotel directory.

Survey administration
A questionnaire was developed based on a literature review of prior studies, and the
research instrument was pre-tested using six participants: the financial controllers of
two large firms; three academics who had significant industry experience; and one
forensic accountant, whose firm specialised in forensic consulting. After some minor
changes to wording in several questions, the questionnaire was mailed to the financial
MAJ controller (or chief accountant) of each firm. Financial controllers were chosen as
23,2 survey participants for two key reasons. Firstly, they are in a senior position and thus,
are expected to have a very good understanding of the quality of ICP. In particular,
financial controllers are often actively involved in the oversight of any system reviews
and changes, and thus were expected to have greater awareness of any weaknesses or
malfunctions of ICP. Secondly, financial controllers are also generally more informed
112 and aware of incidences of fraud across different sections of an organization,
particularly in the reporting and investigation of such incidences. The survey
questionnaire was accompanied by a letter to introduce the purpose of the study along
with a reply paid envelope for their responses. Follow up calls were made
approximately two weeks after the surveys were sent out.
Of the 320 questionnaires sent out to the organizations selected for participation, a
total of 67 responses were received (approximately 21 per cent response rate), of which
64 were useable (18.8 per cent). Three of the returned questionnaires were discarded due
to incomplete responses. Nearly, half the respondents were from large firms, i.e. 100
employees and above and about 28 per cent from less than 49 employees. Of the 64 firms,
21.8 per cent of the respondents had experienced employee fraud. Further, a range of
industries were represented in this study. These were classified into four industry
categories: manufacturing, retail, hotel, and other services[2]. The proportional
distribution of these industries is shown in Table I. The largest sector was the hotel
industry (39 per cent), followed by manufacturing (21.9 per cent), retail (17.2 per cent)
and other services (15.6 per cent).

Variable measurement
Employee fraud. Respondents were asked to indicate whether the firm had uncovered
any instances of fraud that had been committed by an employee or employees. A
dichotomous (yes/no) scale was adopted as the final measure, where “0” represents no
employee fraud, and “1” represents one or more instances of employee fraud.
ICP quality. The ICP quality was assessed based on a seven-item scale, whereby the
items were adapted from a nation-wide survey on internal controls by CPA Australia
(2003). Each participant was required to rate the quality of the internal controls in
seven key areas within the firm. These include “cash management” “bank accounts”
“physical assets” “purchasing and accounts payable” “sales” “employee recruitment”
and “payroll”. A seven-point Likert-type scale anchored at both ends with 1 – very
poor to 7 – very good was utilised. Data analyses were based on the average score of
all seven-items for each participant. The internal reliability of the measure was high
with a Cronbach a of 0.89 (Nunnally, 1967).

Industry Number of respondents Percentage

Hotel 25 39.0
Manufacturing 14 21.9
Retail 11 17.2
Table I. Other services 10 15.6
Sample respondents Unstated 4 6.3
by industry Total 64 100.0
Organizational justice perceptions. This variable was measured based on the survey Quality of
participant’s assessment of the employees’s views on the fairness of the rules and policies internal control
of the organization in terms of both procedural justice and distributive justice dimensions.
An 11-item scale was adopted with questions one to six of the scale based on Moorman’s procedures
(1991) six-item procedural justice scale that assessed respondents’s perceptions of the
degree to which organizational systems and processes exhibit characteristics of
consistency, bias suppression, accuracy, correctability, representativeness and ethicality. 113
The remaining five items, i.e. questions 7 to 11, were based on Niehoff and Moorman’s
(1993) distributive justice assessment of the fairness of different work outcomes such as
pay levels, workload and job responsibilities. The lead question began as follows:
Based on your interactions and feedback from members within your organization, please rate
the extent to which, e.g. “employees perceive their work schedule as being fair” “employees
are allowed to challenge or appeal job decisions made by the general manager”, etc.
A seven-point Likert scale was adopted where 1 – not at all to 7 – a great extent. The
test of internal reliability for all 11 items was very high with the Cronbach a being 0.93.
Data analyses were based on the average score of the 11 items.
The results of a factor analysis of the organizational justice scale revealed a
two-factor solution indicating, as expected, the existence of two sub-dimensions. The
first factor reflected the procedural justice dimension as found by Moorman (1991), and
the second factor reflecting the distributive justice dimension as adopted in Niehoff and
Moorman (1993).
In addition, because the measure of organizational justice was based on the survey
participants’s (i.e. the financial controllers’s) understanding of how employees felt about
their organization, we undertook an additional measure to verify the extent of the
participants’s interactions with other employees. Each participant was asked to rate his
or her level of interaction with staff along four classifications: no or minimal interaction;
some interaction; quite a lot of interaction; to a great deal of interaction. About 83 per cent
of the survey participants rated that they had either “quite a lot of interaction” or “a great
deal of interaction” with other staff, with the remaining 17 per cent of respondents
indicating as having “some interaction”. No respondent reported having only “no or
minimal interaction” with staff. Thus, it appears that the survey participants’s
assessment of organizational justice is highly likely to be congruent with the
employees’s perceptions.
Corporate ethical environment. Corporate ethical environment was measured using a
five item, five-point Likert-type scale as developed by Hunt et al. (1989). Corporate ethical
environment was evaluated using the ethical tone at the senior management level
because COSO (1992) asserts that the overall ethical tone in an organization is developed
from the top down, and must be exemplified to the lower staff levels of the organization
before ethical values are assimilated by the whole organization. The measure consisted
of statements such as, “Top management in my organization has let it be known that
unethical behaviour will not be tolerated” “Managers in my organization often engage in
unethical behaviour” and:
If a manager in my organization is discovered to have engaged in unethical behaviour that
results primarily in the entity’s gain (rather than personal gain) he or she will be promptly
reprimanded.
MAJ The Cronbach a evaluating the internal reliability of the scale is 0.809. Further, a factor
23,2 analysis reveals a unidimensional scale for the five-item ethical environment construct.
Risk management training. Each respondent was asked to rate on a seven-point
Likert scale the extent of formal training undertaken by staff on risk management
procedures, whereby 1 – not at all to 7 – to a large extent.
Internal audit. Each respondent was asked “To what extent did your organization,
114 in the last financial year undertake internal audit activities?”. An eight-point scale was
provided with 0 being “none” 1 representing to “a very small extent” and 7 signifying
“a very large extent”.
Organizational size. Organizational size was evaluated by measuring the number of
employees in the organization.

Statistical analyses
Model 1
The first model tests H1 by using a logistic regression analysis, where the dependent
variable, i.e. the incidence of fraud, was regressed against ICP quality, OJP, and the
multiplicative interaction term between the two variables. Organizational size was
included in the regression model as a control variable. It has been argued that
employee fraud tends to occur more frequently in smaller firms due to lack of
segregation of duties, but a counter argument is that larger organizations can be more
open to fraud due to their complexity and large volumes of transactions which allow
fraud to go undetected more easily (Marden and Edwards, 2005; Ziegenfuss, 1996). The
regression equation thus is as follows:

PrðY ¼ 1Þ ¼ F½b0 þ b1 X 1 þ b2 X 2 þ b3 X 1 *X 2 þ b4 X 3
ð1Þ

where: Pr(Y ¼ 1) – employee fraud incidence; X1 – ICP quality; X2 – employee
perceptions of organizational justice; X1*X2 – the interaction term; X3 –
organizational size.
A significant coefficient of the multiplicative term b3 will support H1. Further, an
inherent problem when using interaction regression models is the likely existence of
multicollinearity among the independent variables (Southwood, 1978).
Multicollinearity may have adverse effects on the regression statistics, rendering
them misleading and producing “imprecise estimates of regression coefficients”
(Pedhazur, 1997, p. 295). Jaccard and Turrisi (2003) advocate the use of employing
the “mean-centred” approach, where the scores on the independent variables are
calculated according to their deviation from the mean. As such, the independent
variables X1 and X2 for this study are the centred scores where each individual
response is subtracted from the mean for each case.

Model 2
The second model tests H2 by using an OLS multiple regression analysis. The
dependent variable, ICP quality was regressed against the three independent variables,
namely, corporate ethical environment, RMT and IA activities. In addition, the equation
included organizational size as a control variable. Prior literature suggests that larger
firms tend to have better resources for developing more sophisticated governance
structures (Duncan et al., 1999), and a larger number of employees which facilitates
segregation of duties more easily. The OLS regression equation thus is as follows:
 Y ¼ b0 þ b1 X 1 þ b 2 X 2 þ b3 X 3 þ b4 X 4 ð2Þ Quality of
internal control
where: Y – ICP quality; X1 – ethical environment; X2 – RMT; X3 – IA activities; X4 –
organizational size. procedures
A significant coefficient for X1, X2, and X3, i.e. b1, b2 and b3 will support H2-H4,
respectively.
115
Results
Results of Model 1
The descriptive statistics of the variables and the correlation matrix for Model 1 are
presented in Table II, and the results of Model 1 are provided in Table III. For this
model, the regression analysis yielded a Nagelkerke R 2 of 20.4 per cent, and log
likelihood being 55.71.
Further, as shown in Table III, the coefficient of the interaction term, b3, is both
negative and significant, thus, supporting H1 (Wald ¼ 3.55, p , 0.05). The negative
coefficient of the interaction term suggests that, as ICP quality become stronger and as
employees have a more favourable perception of organizational procedural justice, the
incidence of employee fraud decreases. Table III also provides the results of the
additive model, i.e. Model 1 without the interaction term. Interestingly, the coefficients
for each of the independent variables are not significant, suggesting that the direct
relationships between OJP and ICP quality with employee fraud incidence are not
significant.

Correlation matrix
Theoretical Actual Employee
Variables Mean SD range range ICPQ OJP fraud

ICPQ 5.68 0.813 1-7 3.57-7.0 1.00

Organizational justice
perceptions 4.97 0.876 1-7 2.64-6.55 0.450 * 1.00
Employee fraud 0.22 0.414 0-1 0-1.00 2 0.132 2 0.050 1.00 Table II.
Organizational size Model 1 – descriptive
statistics and correlation
Note: *Correlation is significant at the 0.01 level (one-tailed) matrix (n ¼ 64)

Interaction model Additive model

Coefficient Std Signif. Coefficient Std Signif.
Variables values error ( p) Wald values error ( p) Wald

Organizational justice 9.792 5.244 0.03 3.49 20.062 0.404 0.44 0.02
ICPQ 7.853 4.355 0.04 3.25 20.229 0.443 0.31 0.27
ICPQ and organizational
justice interaction 2 1.701 0.902 0.03 3.55
Organizational size 0.417 0.291 0.08 2.06 0.515 0.284 0.04 3.30
Table III.
Constant 2 3.737 1.528 0.01 5.98 23.837 1.456 0.00 6.95
Model 1 – logit
Notes: Model summary: 22 log likelihood ¼ 55.71; Nagelkerke R 2 ¼ 0.204; model x 2 ¼ 13.835, regression results
df ¼ 8, p ¼ 0.09 (n ¼ 64)
MAJ These results suggest that the combined effect of low perceptions of organizational
23,2 justice and poor internal controls together have a stronger association with the
incidence of fraud rather than the direct associations of each of the independent
variables separately. The control variable, organizational size, appears to be only
marginally related to employee fraud in the interaction model with a significance level
of p ¼ 0.08. A positive sign of the coefficient (b4) indicates that the probability of
116 employee fraud occurrence is higher in larger organizations. Further, discussion of
these findings is undertaken in the “Discussion of results” section.

Results of Model 2
The descriptive statistics and the correlation matrix for the variables of Model 2 are
presented in Table IV.
Table V provides the results of the regression analysis for Model 2. The overall
model is significant (F-value ¼ 6.976; p , 0.001) with an adjusted R 2 of 27.5 per cent.
Further, the coefficients of the three predictor variables:
(1) corporate ethical environment;
(2) the extent of RMT; and
(3) the extent of the IA activities are also significant, and as predicted are all
positively related to the strength of ICP.

H2-H4, are thus supported. The coefficients (i.e. b1, b2 and b3) are all positive indicating
that the stronger the corporate ethical environment of the firm, the higher the perceived
quality of ICP, and likewise, the greater the extent of RMT and the greater the extent of
IA activities within the firm, the greater the ICP quality. However, organizational size is
not seen to be significantly related with ICP quality. Further, discussion of the
implications of the results is undertaken in the “Discussion of results” section.

Sensitivity analysis
In this study, two types of additional sensitivity analyses were conducted. First,
models one and two were re-run by including industry type (as a dummy variable; 1 –
hotels and 0 – non-hotel) as an additional variable to the original regression equations.
This additional analysis was undertaken because a substantial portion of respondents
in the study are from the hotel industry, i.e. 39 per cent (or 25 out of the 64 participants).
Interestingly, the results do not reveal any significant industry effect, thus suggesting
that the results of models one and two apply equally across the hotel and non-hotel
industries.
Second, because the variable, OJP, comprises two sub-dimensions: distributive and
procedural justice, Model 1 was re-run with each sub-dimension replacing the original
organizational justice measure with the aim of assessing the impact of the interaction
of each of the sub-dimensions with ICP quality on employee fraud[3]. The results of
these two new interaction models were both consistent with original Model 1’s output,
i.e. the findings related to the overall measure of organizational justice procedure.
Specifically, the findings suggest that as perceptions of organizational procedural
justice decrease and ICP quality becomes lower, the probability of employee fraud
tends to increase. Similarly, as perceptions of distributive justice decrease and ICP
quality deteriorates, employee fraud is expected to increase.
 Correlation matrix
Variables Mean SD Theoretical range Actual range Ethical environment RMT IA Organizational size

Ethical environment 4.19 0.648 1-5 2.2-5.0 1.00

Risk management training 3.41 1.875 1-7 1.0-7.0 0.422 * * 1.00
Internal audit activities 3.85 2.160 0-7 0.0-7.0 0.033 0.259 * 1.00
ICPS 5.66 0.818 1-7 3.5-7.0 0.343 * * 0.465 * * 0.358 * *
Organizational size
Notes: *Correlation is significant at the 0.05 level (two-tailed); * *correlation is significant at the 0.01 level (two-tailed)

statistics and correlation

internal control
procedures

Model 2 – descriptive

matrix (n ¼ 64)
117

Table IV.
Quality of
MAJ Fraud occurrences
23,2 In this study, of 64 respondents, 14 of the firms had experienced employee fraud in the
previous two years, that is, from 2002 to 2004. Of those firms, exactly half of them had
only one instance of fraud, while the other half experienced more than one instance of
fraud during the period. Table VI provides a detailed breakdown of the frequencies of
fraud occurrences.
118 Given that there are often difficulties in quantifying the exact amount of financial
loss sustained due to theft by employees, respondents were asked to provide an
estimate of the amount of loss. The dollar value of the frauds experienced was
estimated to range from A$100 to 300,000. The average dollar value of estimated fraud
losses per firm across the 14 firms was $34,457, while the average estimated fraud
losses per fraud were $18,554 for 26 individual instances of fraud.

Discussion of the results

The results of H1 support the interaction between ICP quality and OJP, indicating a
significant effect on employee fraud. As such, these results provide empirical support
for the “fraud triangle” framework as proposed by Albrecht (1996), and specifically,
suggest that employee fraud increases when both the motivation (i.e. the incentive
and/or rationalisation) and the opportunity to do so exists. In assuming OJP as a
factor affecting the incentive and rationalisation for committing fraud and the quality
of ICP as a proxy for opportunity to commit fraud, this study has brought together two
key literatures to explain employee fraud. The findings of this study also extend prior
empirical evidence on the impact of organizational justice on workplace deviance or
aggression (Greenberg, 1990; Williams, 1999; Henle, 2005) by revealing the ICP quality
as a significant moderating factor of such relationships.

Variables Coefficient values Std error t-valuea p-value VIF

Ethical environment 0.273 0.150 1.683 0.045 1.224

RMT 0.139 0.053 2.557 0.007 1.312
IA 0.115 0.043 2.611 0.006 1.155
Organizational size 2 0.064 0.069 2 0.0930 0.178 1.084
Table V. Constant 4.017 0.660 6.091 0.000
Model 2 – OLS
regression results Notes: aOne-tailed test; F-value ¼ 6.976; p ¼ 0.001; adjusted R 2 ¼ 27.5 per cent

Frequency of fraud Number of firms experiencing this fraud Number of instances of

occurrence frequency fraud

1 7 7
2 5 10
3 0 0
Table VI. 4 1 4
Frequency of employee 5 1 5
fraud occurrences Total 14 26
The results also suggest that in designing effective management control systems, Quality of
attention needs to be paid to both the quality of ICP as well as to the fairness of internal control
distributive and procedural policies at the workplace as strategies for minimizing
employee fraud. Managers may be able to reduce the incidence of fraud by ensuring procedures
employee performance evaluation and reward processes are fair, and making necessary
changes to produce better employee outcomes through improving OJP within the
organization. Niehoff and Moorman (1993) indicate that employee perceptions of 119
organizational justice may be improved through sensitive, open communication
between employers and employees regarding employee performance evaluation and
outcomes. This means that organizational policies in evaluating and rewarding
employees must be explained and justified, and employees must feel that they are able to
appeal or challenge decisions that adversely affect them. The creation of any undue
pressure through unfair processes or unrealistic performance targets for employees,
thus, ought to be avoided as they will only work to increase the likelihood of employee
retaliation, such as fraud.
Further, recent legislative developments have paid significant attention to
establishing and enhancing appropriate governance measures controls. For example,
the Sarbanes-Oxley Act (2002) requires an annual audit of management’s report on
their internal controls, and Australia’s ASA 210 requires auditors to evaluate the
design of the internal control systems to assess the risk of fraud. However, the results
of this study also suggest that such mandatory requirements and guidelines ought to
further emphasise audit procedures that evaluate the existence of an equitable and fair
work environment. The auditor’s scepticism for fraud ought to increase when both ICP
quality and the OJP environment of the firm appear to be poor.
This study also found significant links between ICP quality and several components
of COSO’s (2004) overall internal control system framework, namely the internal
environment, risk assessment policies and monitoring activities. More specifically, the
findings suggest that the following three factors, namely the corporate ethical
environment, the extent of RMT and IA activities, all have a positive effect on the
strength of ICP. These results suggest that employees can be encouraged to adhere to
ICP through a multi-approach strategy composed of promoting ethical values,
increasing RMT and more extensive IA activities. Also, the results highlight to senior
managers the importance of setting appropriate ethical standards and ensuring that
adequate resources are available for RMT and IA activities. Further, the results of this
study also potentially lead to better audit procedures when evaluating ICP, whereby
auditors will need to pay more attention to the ethical environment of the entity, RMT
and IA activities within a firm.

Conclusion
In recent years, reducing the incidence of employee fraud has been of interest to
auditors, business owners, shareholders and academics alike because employee fraud
has had, and continues to have, significant economic and social consequences. The
results of this study suggest that the incidence of fraud appears to be higher when both
ICP quality and employee perceptions of organizational justice are poor. As such,
management control strategies for minimizing employee fraud need to consider both
the quality of ICP and the perceived fairness of organizational rules and policies. This
finding also has implications for internal and external auditors when assessing the
MAJ likelihood of fraud. Specifically, the auditors need to pay further attention not only to
23,2 traditional factors such as ICP quality but also to other organizational factors such as
employees’s perceptions of organizational justice.
The second set of findings of this study suggests that organizations which promote
a highly ethical environment, and those that actively conduct RMT and IA activities,
are likely to have strong ICP. Thus, strategies that promote not only high integrity at
120 the workplace, but also staff training on risk management and the existence of
adequate oversight processes through the IA function are critical for the detection and
prevention of fraud.
Nevertheless, the results of this study need to be interpreted in light of several
limitations. First, the responses for this study were largely sourced from the financial
controller or chief accountant of a firm. While these participants may have significant
understanding of factors such as the incidence of fraud and ICP quality, the assessment
of OJP within the firm is based on their own perceptions. However, an assessment of
the degree of interaction by the financial controllers revealed that nearly 85 per cent of
the financial controllers had a great deal of interaction and thus opportunities for
gaining feedback from employees. However, future studies may aim to measure OJP
through using a collective measure based on a direct survey of employees and multiple
respondents within a firm. The second limitation of this study relates to the
measurement of the “ICP quality” construct, which was also based on the financial
controllers’s assessment. Perhaps, a more objective measure of the design of the “ICP
quality” construct may be gained by evaluating the resources and sophistication of the
various policies and procedures. Further, future studies may adopt a weighted measure
of ICP quality, whereby the assessment of multiple parties including financial
controllers, internal and external auditors may be used for a more holistic assessment.
The third limitation relates to employee fraud measured as a dichotomous variable. A
more informative measure of the construct may have been to measure employee fraud
in terms of its severity, assessing the dollar value of the net loss sustained by each firm
as a victim of fraud. Future studies may thus focus on the costs of employee fraud and
not just on the incidence of fraud. Last but not least, the usual caveats of survey
research are applicable.
In conclusion, this study provides timely empirical evidence on the importance of
both ICP quality and fairness of organizational policies such as the perceived
procedural and distributive fairness in the workplace for deterring employee fraud.
Further, the study also highlights the need for the evolving governance practices and
related legislation and practice guidelines to pay significant attention to an array of
management control features. These features include the role of oversight mechanisms
such as ICP, RMT and IA activities, as well as organizational policies and procedures
that deal with issues of fairness and integrity at the workplace.

Notes
1. It is also acknowledged that while internal control is a process, its effectiveness is a state or
condition of the process at one or more points in time.
2. Four respondents had to be categorised as “unstated” as per the ethical guidelines of the
Griffith University’s Social Sciences, Business, and Arts Ethics Sub-Committee. Each letter
 sought the respondent’s participation in fully completing the survey, and allowed the Quality of
opportunity for each participant to remain anonymous.
internal control
3. As reported under the “variable measurement” section, a factor analysis of the 11-item
measure of organizational justice perceptions used in this study revealed the two theoretical procedures
sub-dimensions, i.e. Moorman’s (1991) six-item procedural justice dimension and Niehoff and
Moorman’s (1993) distributive justice dimension.
121
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124
Corresponding author
Nava Subramaniam can be contacted at: N.Subramaniam@griffith.edu.au

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