IDEAS home Printed from https://ideas.repec.org/p/eie/wpaper/0909.html
   My bibliography  Save this paper

Corporate Fraud, Governance and Auditing

Author

Listed:
  • Marco Pagano

    (Università di Napoli "Federico II", CSEF, EIEF and CEPR)

  • Giovanni Immordino

    (Università di Salerno and CSEF)

Abstract

We analyze corporate fraud in a setting in which managers have superior information but are biased against liquidation, because of their private benefits from empire building. This may induce them to misreport information and even bribe auditors when liquidation would be value-increasing. To curb fraud, shareholders optimally design internal corporate governance, by choosing audit quality and managerial compensation. Both internal governance mechanisms tend to substitute for poor shareholder protection; in contrast, audit quality tends to complement stricter auditing regulation. We also find that severance pay dominates both equity and option-based pay in improving managerial incentives.

Suggested Citation

  • Marco Pagano & Giovanni Immordino, 2009. "Corporate Fraud, Governance and Auditing," EIEF Working Papers Series 0909, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2009.
    • Handle: RePEc:eie:wpaper:0909
    as

    Download full text from publisher

    File URL: http://www.eief.it/files/2012/09/wp-09-corporate-fraud-governance-and-auditing.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Bergstresser, Daniel & Philippon, Thomas, 2006. "CEO incentives and earnings management," Journal of Financial Economics, Elsevier, vol. 80(3), pages 511-529, June.
    2. Burns, Natasha & Kedia, Simi, 2006. "The impact of performance-based compensation on misreporting," Journal of Financial Economics, Elsevier, vol. 79(1), pages 35-67, January.
    3. Klapper, Leora F. & Love, Inessa, 2004. "Corporate governance, investor protection, and performance in emerging markets," Journal of Corporate Finance, Elsevier, vol. 10(5), pages 703-728, November.
    4. Marco Pagano & Giovanni Immordino, 2007. "Optimal Regulation of Auditing," CESifo Economic Studies, CESifo Group, vol. 53(3), pages 363-388, September.
    5. Roman Inderst & Holger M. Mueller, 2010. "CEO Replacement Under Private Information," The Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 2935-2969, August.
    6. Doidge, Craig & Andrew Karolyi, G. & Stulz, Rene M., 2007. "Why do countries matter so much for corporate governance?," Journal of Financial Economics, Elsevier, vol. 86(1), pages 1-39, October.
    7. Ingolf Dittmann & Ernst Maug, 2007. "Lower Salaries and No Options? On the Optimal Structure of Executive Pay," Journal of Finance, American Finance Association, vol. 62(1), pages 303-343, February.
    8. Reena Aggarwal & Isil Erel & René Stulz & Rohan Williamson, 2010. "Differences in Governance Practices between U.S. and Foreign Firms: Measurement, Causes, and Consequences," The Review of Financial Studies, Society for Financial Studies, vol. 23(3), pages 3131-3169, March.
    9. Francis, Jere R., 2004. "What do we know about audit quality?," The British Accounting Review, Elsevier, vol. 36(4), pages 345-368.
    10. Seetharaman, Ananth & Gul, Ferdinand A. & Lynn, Stephen G., 2002. "Litigation risk and audit fees: evidence from UK firms cross-listed on US markets," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 91-115, February.
    11. Lins, Karl V., 2003. "Equity Ownership and Firm Value in Emerging Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(1), pages 159-184, March.
    12. Patricia M. Dechow & Richard G. Sloan & Amy P. Sweeney, 1996. "Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC," Contemporary Accounting Research, John Wiley & Sons, vol. 13(1), pages 1-36, March.
    13. Art Durnev & E. Han Kim, 2005. "To Steal or Not to Steal: Firm Attributes, Legal Environment, and Valuation," Journal of Finance, American Finance Association, vol. 60(3), pages 1461-1493, June.
    14. Kevin J. Murphy & Brian J. Hall, 2000. "Optimal Exercise Prices for Executive Stock Options," American Economic Review, American Economic Association, vol. 90(2), pages 209-214, May.
    15. Steven D. Levitt & Christopher M. Snyder, 1997. "Is No. News Bad News? Information Transmission and the Role of "Early Warning" in the Principal-Agent Model," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 641-661, Winter.
    16. Simi Kedia & Thomas Philippon, 2009. "The Economics of Fraudulent Accounting," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2169-2199, June.
    17. Paul Povel & Rajdeep Singh & Andrew Winton, 2007. "Booms, Busts, and Fraud," The Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1219-1254.
    18. Klein, April, 2002. "Audit committee, board of director characteristics, and earnings management," Journal of Accounting and Economics, Elsevier, vol. 33(3), pages 375-400, August.
    19. Jonathan M. Karpoff & D. Scott Lee & Gerald S. Martin, 2014. "The Consequences to Managers for Financial Misrepresentation," Springer Books, in: Roberto Pietra & Stuart McLeay & Joshua Ronen (ed.), Accounting and Regulation, edition 127, chapter 0, pages 339-375, Springer.
    20. Eisfeldt, Andrea L. & Rampini, Adriano A., 2008. "Managerial incentives, capital reallocation, and the business cycle," Journal of Financial Economics, Elsevier, vol. 87(1), pages 177-199, January.
    21. Volker Laux, 2008. "Board Independence and CEO Turnover," Journal of Accounting Research, Wiley Blackwell, vol. 46(1), pages 137-171, March.
    22. Jere R. Francis & Dechun Wang, 2008. "The Joint Effect of Investor Protection and Big 4 Audits on Earnings Quality around the World," Contemporary Accounting Research, John Wiley & Sons, vol. 25(1), pages 157-191, March.
    23. Tracy Yue Wang & Andrew Winton & Xiaoyun Yu, 2010. "Corporate Fraud and Business Conditions: Evidence from IPOs," Journal of Finance, American Finance Association, vol. 65(6), pages 2255-2292, December.
    24. Lin Peng & Ailsa Röell, 2008. "Executive pay and shareholder litigation," Review of Finance, European Finance Association, vol. 12(1), pages 141-184.
    25. Goldman, Eitan & Slezak, Steve L., 2006. "An equilibrium model of incentive contracts in the presence of information manipulation," Journal of Financial Economics, Elsevier, vol. 80(3), pages 603-626, June.
    26. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(4), pages 391-405, December.
    27. Dye, Ronald A, 1993. "Auditing Standards, Legal Liability, and Auditor Wealth," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 887-914, October.
    28. Agrawal, Anup & Chadha, Sahiba, 2005. "Corporate Governance and Accounting Scandals," Journal of Law and Economics, University of Chicago Press, vol. 48(2), pages 371-406, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Maurizio Iacopetta & Raoul Minetti & Pietro F Peretto, 2019. "Financial Markets, Industry Dynamics and Growth," The Economic Journal, Royal Economic Society, vol. 129(621), pages 2192-2215.
    2. Marco Pagano & Giovanni Immordino, 2007. "Optimal Regulation of Auditing," CESifo Economic Studies, CESifo Group, vol. 53(3), pages 363-388, September.
    3. Brito, Duarte & Elhauge, Einer & Ribeiro, Ricardo & Vasconcelos, Helder, 2023. "Modelling the objective function of managers in the presence of overlapping shareholding," International Journal of Industrial Organization, Elsevier, vol. 87(C).
    4. Irena Hutton & Danling Jiang & Alok Kumar, 2015. "Political Values, Culture, and Corporate Litigation," Management Science, INFORMS, vol. 61(12), pages 2905-2925, December.
    5. Maurizio Iacopetta & Raoul Minetti & Pietro F Peretto, 2019. "Financial Markets, Industry Dynamics and Growth," Economic Journal, Royal Economic Society, vol. 129(621), pages 2192-2215.
    6. Shalini TALWAR & Chitra PUNDIR, 2019. "Corporate Governance: A Look through the Auditing Lens with reference to India," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 1, pages 78-84.
    7. Mark A. Chen & Daniel T. Greene & James E. Owers, 2015. "The Costs and Benefits of Clawback Provisions in CEO Compensation," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 4(1), pages 108-154.
    8. repec:hal:spmain:info:hdl:2441/1ani1qs24g9in97gbhnanm575u is not listed on IDEAS

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dan Amiram & Zahn Bozanic & James D. Cox & Quentin Dupont & Jonathan M. Karpoff & Richard Sloan, 2018. "Financial reporting fraud and other forms of misconduct: a multidisciplinary review of the literature," Review of Accounting Studies, Springer, vol. 23(2), pages 732-783, June.
    2. Abdul Ghafoor & Rozaimah Zainudin & Nurul Shahnaz Mahdzan, 2019. "Factors Eliciting Corporate Fraud in Emerging Markets: Case of Firms Subject to Enforcement Actions in Malaysia," Journal of Business Ethics, Springer, vol. 160(2), pages 587-608, December.
    3. Jian Zhang, 2018. "Public Governance and Corporate Fraud: Evidence from the Recent Anti-corruption Campaign in China," Journal of Business Ethics, Springer, vol. 148(2), pages 375-396, March.
    4. Andergassen, Rainer, 2016. "Managerial compensation, product market competition and fraud," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 1-15.
    5. Hoberg, Gerard & Lewis, Craig, 2017. "Do fraudulent firms produce abnormal disclosure?," Journal of Corporate Finance, Elsevier, vol. 43(C), pages 58-85.
    6. Zhou, Fangzhao & Zhang, Zenan & Yang, Jun & Su, Yunpeng & An, Yunbi, 2018. "Delisting pressure, executive compensation, and corporate fraud: Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 48(C), pages 17-34.
    7. Li, Xingli & Pukthuanthong, Kuntara & Glenn Walker, Marcus & Walker, Thomas John, 2016. "The determinants of IPO-related shareholder litigation: The role of CEO equity incentives and corporate governance," Journal of Financial Markets, Elsevier, vol. 31(C), pages 81-126.
    8. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    9. Katherine Guthrie & Illoong Kwon & Jan Sokolowsky, 2017. "What Does CEOs’ Pay-for-Performance Reveal About Shareholders’ Attitude Toward Earnings Overstatements?," Journal of Business Ethics, Springer, vol. 146(2), pages 419-450, December.
    10. Wu, Yan Wendy, 2011. "Optimal executive compensation: Stock options or restricted stocks," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 633-644, October.
    11. Anup Agrawal & Tommy Cooper, 2017. "Corporate Governance Consequences of Accounting Scandals: Evidence from Top Management, CFO and Auditor Turnover," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 7(01), pages 1-41, March.
    12. Zhang, Jian & Wang, Jialong & Kong, Dongmin, 2020. "Employee treatment and corporate fraud," Economic Modelling, Elsevier, vol. 85(C), pages 325-334.
    13. Agrawal, Anup & Cooper, Tommy, 2015. "Insider trading before accounting scandals," Journal of Corporate Finance, Elsevier, vol. 34(C), pages 169-190.
    14. Irena Hutton & Danling Jiang & Alok Kumar, 2015. "Political Values, Culture, and Corporate Litigation," Management Science, INFORMS, vol. 61(12), pages 2905-2925, December.
    15. Hazarika, Sonali & Karpoff, Jonathan M. & Nahata, Rajarishi, 2012. "Internal corporate governance, CEO turnover, and earnings management," Journal of Financial Economics, Elsevier, vol. 104(1), pages 44-69.
    16. Brandon Julio & Youngsuk Yook, 2016. "Earnings Management and Corporate Investment Decisions," Finance and Economics Discussion Series 2016-086, Board of Governors of the Federal Reserve System (U.S.).
    17. DeFond, Mark & Zhang, Jieying, 2014. "A review of archival auditing research," Journal of Accounting and Economics, Elsevier, vol. 58(2), pages 275-326.
    18. Wang, Tracy Yue & Winton, Andrew, 2021. "Industry informational interactions and corporate fraud," Journal of Corporate Finance, Elsevier, vol. 69(C).
    19. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    20. Lars Moratis & Max van Egmond, 2018. "Concealing social responsibility? Investigating the relationship between CSR, earnings management and the effect of industry through quantitative analysis," International Journal of Corporate Social Responsibility, Springer, vol. 3(1), pages 1-13, December.

    More about this item

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • M42 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Auditing

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eie:wpaper:0909. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Facundo Piguillem (email available below). General contact details of provider: https://edirc.repec.org/data/einauit.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.