The Composition and Compensation of the Board of Directors as Predictors of Corporate Fraud

Abstract

We test whether the composition and compensation of the board of directors are related to fraudulent corporate behavior. We use Accounting and Auditing Enforcement Releases from 2003 through 2010 to form a sample of 128 firms with violations and compare the characteristics of their boards to a matched sample of 128 control firms. SEC violations are less likely when the board has more women, independent members, and financial experts. Fraud is also less likely when director tenure is shorter and when the CEO is not the chair. Stock and especially stock option compensation are positively associated with SEC violations.

Contrasting Incentives for Earnings Management: Board Activity and Board Remuneration in Spanish Firms

“…Performance-based compensation will align directors' and shareholders' interests and will also provide information about the fact that more attention to shareholder value maximization reinforces the role of the board in preventing EM. A similar conclusion on the alignment approach is reached by Kim, Roden and Cox [13], who suggest that greater cash-based compensations are used to attract quality directors, as well as to establish a better agency relationship between directors and shareholders than equity-based compensation.…”

The Quad Model for Identifying a Corporate Director’s Potential for Effective Monitoring: Toward a New Theory of Board Sufficiency

“…To test the quad model, a researcher would focus on a specific domain or form of governance failure -such as financial fraud, excessive CEO compensation, or acquisition overpayments -and generate a sample of firms that vary on this outcome measure (possibly using matched-pairs, state-based sampling, or random sampling (e.g., Harris & Bromiley, 2007;Kim et al, 2013)). Next, the researcher would need to develop operationalizations of the four elements of the quad model, guided by prior research or new insights (including from our Table 1), and then code for the presence vs. absence of each quality in each director (in the period leading up to the observed outcome).…”

The Relationship between Board Diversity, Board Independence and Corporate Fraud

“…The results of the study by Cumming et al (2014) found negative relationship between gender diversity and securities fraud and indicated that the increase number of women in the boardroom decreases the occurrence of securities fraud. The results of the study by Kim, Roden & Cox (2013) presented a negative relationship between gender diversity and corporate fraud. The results of the study by Gavious, Segef & Yosef (2012) posited a negative relationship between the presence of female directors and earnings management.…”

“…The results of the study by Xu, Zhang & Chen (2018) found that board age is negatively related to the likelihood of corporate financial fraud. The results of the study by Kim et al (2013) posited a negative relationship between age and the likelihood of fraud. On the contrary, the results of the study by Hasnan et al (2016) found that the effects of board characteristics on financial restatements in Malaysia fail to document a statistically significant association for board age.…”

“…Notwithstanding the limited study on the relationship between the board education diversity and corporate fraud, a study by Kim et al (2013) evidenced that the coefficient on the percentage of finance and accounting professionals on the board is significantly negative whereby fraud is less likely to occur when more board members have finance and accounting background. On the other hand, the study by Johari et al (2008) explained that the inclusion of directors with good accounting and finance academic/professional background does not make any difference in the earnings management practices.…”