Academic journal article Entrepreneurial Executive

Fraud: A Concomitant Cause of Small Business Failure

Academic journal article Entrepreneurial Executive

Fraud: A Concomitant Cause of Small Business Failure

Article excerpt


This paper presents evidence to support a new perspective: the majority of small businesses fail because of fraud. Fraud occurs in small firms at 100 times the rate for large firms, and the overwhelming majority of frauds are committed by honest employees who have a perceived need, recognize an opportunity, perceive the probability of detection as low, and have the ability to rationalize their behavior. The authors present a plan for dramatically reducing fraud; one which does not increase costs or rely upon accountants, and which can be implemented by any small business. The best deterrence to fraud is fear of social sanction: i.e., the loss of the respect of one's peers. The proposed plan creates a climate in which these sanctions will prevail.


Small business failure is one of the most serious economic problems in the United States. If one had the solution to the problem, one would have the power to wipe out unemployment, revitalize downtown areas, eliminate trade deficits, and give the economy such a boost that it would carry the nation into the third millennium, all with a single wave of the magic wand. No one has such a solution, but that may be because no one is willing to recognize the cause. The study of small business failure has been so institutionalized, that the causes of failure have become cliches: managerial incompetence, undercapitalization, etc. These antecedents of failure are so endemic to the process of entrepreneurship that they appear to be insoluble.

What if the traditional perspective is flawed? What if there is another factor which has gone unrecognized and which actually precipitates the majority of small business failures? What if this factor is not only vulnerable, but soluble? If so, then everything changes and small business failure is no longer a sad, but inevitable fact of entrepreneurial life; it is a plague which can be attacked, mitigated, perhaps even eliminated.

This paper will present a new perspective of small business failure: the majority of small businesses fail because of fraud. The authors will examine the traditional perspective and present evidence to support their position. The paper will close with a plan for dramatically reducing fraud in a small business setting; a plan which does not drive up costs or rely upon accountants and auditors, and a plan which can be implemented by any small business owner.


Hambrick and D'Aveni (1988) found that the process of failure in large corporations is a long downward spiral. Perhaps that conclusion is true for large businesses, but small businesses do not follow the time frame of a multi-million dollar company, but rather they experience failure swiftly and finally. Among the studies which support the more cataclysmic nature of small business failure is Venkataraman, Van de Ven, Buckeye, and Hudson (1990) who identified ten companies which developed educational software and followed their progress from 1983 to 1984, a year of turbulence within the computer industry. Six of the ten companies experienced cash flow problems during that time period, and 40% obtained new equity or long-term debt during 1984, although the additional capital did not usually solve their cash flow problems. All six firms underwent dramatic turnarounds, and the study concluded, at least for small firms operating in a turbulent environment, that failure is catastrophic, not downward spiraling.

One of the primary reasons for sudden failure is the smallness of the firms themselves. Bradley and Rubach (1999) suggested that the liability of smallness, in fact, carries its own potential for failure as smallness translates into a lack of sufficient financial resources. They found that leveraging had a negative effect on business success, and demonstrated that the majority of small firms borrow substantial sums to operate their businesses.

The inescapable conclusion is that small firms, by their very nature, have shallow pockets and high debt levels. …

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