Corporate Governance and Fraudulent Reporting: Relationships Examined

Nicola M Bourke
New Zealand Customs
New Zealand

Karen Van Peursem
Department of Accounting, University of Waikato
New Zealand

Ian Eggleton
Department of Accounting, University of Waikato
New Zealand

Abstract:
Recent and significant scandals have involved the fraudulent manipulation of financial information by management or others interested in deceiving shareholders and the public. This has resulted in immeasurable losses to shareholders, employees and others. Questions have arisen as to the role of the corporate governing body in these fraudulent actions, and recent legislation and listing regulations have been part of the effort to respond to identify or correct such problems. This study is also concerned with fraudulent financial reporting as it explores the question of whether and how corporate board attributes predict such events.

Fieldwork collects relevant information as to corporate governance characteristics for U.S. corporations, and ultimately a literature-informed and statistically-tested and –developed model is produced. Prior literature in the field justifies the selection of twenty potentially predictive variables. Enforcement Releases issued by the Securities Exchange Commission together with other official sites and annual reports are used to derive the extensive range of data used for testing. A significant contribution to the availability of measurable variables is the growth in publicly available information in response to Sarbanes-Oxley (2002) legislation.

Corporate governance characteristics are classified into four broad categories: Audit Committee Functionality, Board of Director Composition, Ownership Structure, and External Auditor Factors. A matched pair research design reduces the original 519 fraud-committing companies identified in 2004-2006 SEC records down to a refined sample 76 companies and their no-fraud equivalents. The results of univariate paired t-tests and a conditional logistic regression equation, together with validation tests, yields the optimal predictive model. The model’s six independent variables are, together, reasonably capable of explaining the variance in whether companies tested are likely to have committed financial fraud. Of the four categories of corporate governance characteristics, Board of Director Composition are the strongest predictors of financial fraud, and Audit Committee characteristics are the weakest. Implications for corporate governance are drawn and considerations for future research conclude the study.