Can Corporate Governance Mechanism Prevent Corporate Fraud?
CORPORATE GOVERNANCE ESSAY
Can Corporate Governance Mechanism Prevent Corporate Fraud?
Executive Summary
This paper will reviews the extent to which corporate governance acts as efficient tool to protect investors against corporate fraud, thus contributing to summarize the literatures on role of corporate governance on preventing occurrence of corporate fraud. In a more recent study, corporate fraud is part of earnings manipulation done outside the law and standards. Whereas, the activities covered by the terms earnings management (such as income smoothing and big bath) and creative accounting (or window dressing) normally remain within the regulations. In this regard, corporate governance mechanism, particularly effective boards, audit committees, and auditors, decrease the likelihood of corporate fraud occurs. At very last contemplation, vigilant structure within corporation as holding stakeholders interests with shift in ethics and values will likely stop greedy executives to take personal advantages.
Keywords: Corporate fraud, earnings management, corporate governance, board effectiveness, audit committee effectiveness and auditor effectiveness.
1. Introduction
There are a number of legal cases involving the accounting manipulation in leading companies in the United States of America (USA) and also other countries, such as Enron and WorldCom in USA, and HIH Insurance and One.Tel in Australia. These have led investors, regulators, and academics to focus on improving dimension of corporate governance to unveil that unethical financial reporting practice. Scholars commonly attribute that poor corporate governance in such companies caused their earnings manipulation. For instance, Lavelle (2002) asserts that Enron’s bankruptcy was caused by the audit committee’s lack of independence, which determined from poor governance, which is part of corporate governance mechanism.
This paper will reviews the extent to which corporate governance acts as
Can Corporate Governance Mechanism Prevent Corporate Fraud?
Executive Summary
This paper will reviews the extent to which corporate governance acts as efficient tool to protect investors against corporate fraud, thus contributing to summarize the literatures on role of corporate governance on preventing occurrence of corporate fraud. In a more recent study, corporate fraud is part of earnings manipulation done outside the law and standards. Whereas, the activities covered by the terms earnings management (such as income smoothing and big bath) and creative accounting (or window dressing) normally remain within the regulations. In this regard, corporate governance mechanism, particularly effective boards, audit committees, and auditors, decrease the likelihood of corporate fraud occurs. At very last contemplation, vigilant structure within corporation as holding stakeholders interests with shift in ethics and values will likely stop greedy executives to take personal advantages.
Keywords: Corporate fraud, earnings management, corporate governance, board effectiveness, audit committee effectiveness and auditor effectiveness.
1. Introduction
There are a number of legal cases involving the accounting manipulation in leading companies in the United States of America (USA) and also other countries, such as Enron and WorldCom in USA, and HIH Insurance and One.Tel in Australia. These have led investors, regulators, and academics to focus on improving dimension of corporate governance to unveil that unethical financial reporting practice. Scholars commonly attribute that poor corporate governance in such companies caused their earnings manipulation. For instance, Lavelle (2002) asserts that Enron’s bankruptcy was caused by the audit committee’s lack of independence, which determined from poor governance, which is part of corporate governance mechanism.
This paper will reviews the extent to which corporate governance acts as
References: ABBOTT, L., PARK, Y. & PARKER, S. (2000) The Effect of Audit Committee Activity and Independence on Corporate Fraud. Managerial Finance, 26, 55-67. ABBOTT, L., PARKER, S. & PETER, G. (2004) Audit Committee Characteristics and Restatements. Auditing: A Journal of Practice and Theory, 23, 69-87. AGRAWAL, A. & CHADHA, S. (2005) Corporate Governance and Accounting Scandals. Journal of Law and Economics, 48, 371-390. AUSTRALIAN SECURITIES EXCHANGE (2008) Corporate Governance Principles and Recommendations. ASX Corporate Governance Council, 2nd Edition. BEASLEY, M. S. (1996) An Empirical Analysis of the Rotation Between the Board of Director Composition and Financial Statement Fraud. Accounting Review, 71, 443-465. BEASLEY, M. S., CARCELLO, J. V., HERMANSON, D. R. & LAPIDES, P. D. (2000) Fraudulent Financial Reporting: Consideration of Industry Traits and Corporate Governance Mechanisms. Accounting Horizons, 14, 441-454. DUNN, P. (2004) The Impact of Insider Power on Fraudulent Financial Reporting. Journal of Management, 30, 397-412. DOPUCH, N., R. R. KING, AND R. SCHWARTZ. (2003) Independence in Appearance and in Fact: An empirical investigation. Contemporary Accounting Research 65, 83-113. FAMA, E. F. & JENSEN, M. C. (1983) Agency Problems and Residual Claims. The Journal of Law and Economics, 26, 327. FARBER, D. B. (2005) Restoring Trust After Fraud: Does Corporate Governance Matter? The Accounting Review, 80, 539-561. JENSEN, M.C. (1993) The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems. The Journal of Finance, 48, 831-880. JOHNSON, V. E., KHURANA, I.K., & REYNOLDS, J.K. (2002) Audit-Firm Tenure and the Quality of Financial Reports. Contemporary Accounting Research, Winter, 637-660. LADAKIS, E. (2005) The Auditor as Gatekeeper for the Investing Public: Auditor Independence and the CLERP Reforms - a Comparative Analysis. Company and Securities Law Journal, 23. LAVALLE, L. (2002) Enron: How Governance Rules Failed. Business Week, 3766, 28-29. LEVITT, A. (1998) The Number Game. Address to NYU Centre for Law and Business, September 28. MYERS, J., MYERS, L. & OMER, T. (2003) Exploring the Term of Auditor-Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation? The Accounting Review, 78 (3), 779-799. ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (2004) OECD Principles of Corporate Governance. PERSONS, O.S. (2006) Corporate Governance and Non-Financial Reporting Fraud. PIOT, C. & JANIN, R. (2005) Audit Quality and Earnings Management in France. SSRN eLibrary. RONEN, J. & YAARI, V. (2006) Earnings Management: Emerging Insight in Theory, Practice, and Research. Springer. STOLOWY, H. & BRETON, G. (2004) Accounts Manipulation: A Literature Review And Proposed Conceptual Framework. The Review of Accounting and Finance, 3, 5-65. UZUN, H., SZEWCZYK, S. H. & VARMA, R. (2004) Board Composition and Corporate Fraud. Financial Analysts Journal, 60 (3), 33-43. WARRICK, W. W. (1999) Post-Blue Ribbon Committee thoughts on developing the audit committee 's charter and annual report. Directorship, 25, 6.