Regulatory risk, borderline legality, fraud and financial restatement

Purpose - Companies vary in their attitudes toward regulatory (ethics) risk. The purpose of this study is to assess how regulatory risk‐averse, risk neutral and risk seeking companies employ distinct managerial risk and slack accumulation strategies and differ in their auditor scores and bankruptcy risk. Design/methodology/approach - The authors test their hypotheses using the GAO‐assembled database of financial restatements that allows contrasting voluntary restaters (firms that restated without being prompted either by external auditors or the SEC) and forced restaters (firms requested to restate by the SEC or external auditors). The paper uses logistic regression for comparing different groups of firms to test the hypotheses. Findings - The results of the data analysis mostly supported the hypotheses. The findings suggest that a firm's attitude towards regulatory risk is associated with organizational slack (available and potential), risk (managerial and organizational), and auditor's rating. Research limitations/implications - Some limitations of the study are: use of cross sectional data does not allow testing causal effects, relying on GAO office for categorizing firms in different regulatory category introduces the possibility of bias in analysis, and use of only North American firms in the sample limits the generalizability of the findings. Practical implications - Firms' attitudes toward regulatory risk and their respective risk and slack management strategies could be used to detect fraud early on before such firms transgress from the realm of legality to borderline legality and illegality. Originality/value - Some contributions of the study are: it shows that a firm's fraud tendency or regulatory risk behavior is associated with the type of slack accumulated and available in the firm, regulatory risk‐averse companies take less managerial and bankruptcy risks, and earn higher evaluations from auditors, it demonstrates that regulatory risk‐averse companies differ from regulatory risk neutral companies.