Si propone un paragrafo dell'articolo "ACCOUNTING FRAUD: A LITERATURE REVIEW" dal titolo "Corporate Governance and Accounting Fraud", redatto da Marco Tutino (Head of Department of Business Studies presso Università degli Studi di Roma Tre) e Matteo Merlo (University of Bologna), 2019.
Pubblicato sulla rivista "Risk Governance and Control: Financial Markets & Institutions", 9(1), 8-25.
Corporate Governance and Accounting Fraud
Corporate governance is a set of rules, regulations and policies that companies have to comply with in order to avoid fraud and misconduct. States themselves try to establish some controls through a regulatory system. These measures which companies decide to adopt concern, mostly, the organization and the board of directors.
Literature has recently focused on the role that CEOs and managers have in accounting fraud. Troy, Smith and Domino (2011) with their article have analysed how some CEOs could be more inclined to commit fraud than others. In particular, they identified that a specific type of managing director, sharing the same characteristics (young, less functionally experienced and without a business degree), are more likely to rationalize an accounting fraud. Moreover, CEO stock options, a tool commonly used to control managers attitude bonding company’s stock prices and some benefits, do not moderate the relationship between CEO experience and the probability of accounting fraud. The results suggest that there is a direct relationship between stock options and accounting fraud.
On the other hand, research conducted by Armstrong et al. (2010) has shown how there is no evidence making a connection between CEO equity incentives and accounting irregularities. Therefore, the results are more consistent with the notion that equity incentives play a role in aligning managers’ interests with those of shareholders.
At the same time, the remuneration of CEOs has its influence on the occurrence of accounting fraud and on other corporate governance problems. Indeed, equity-based pay plans, traditional pay plans and bonus plans could encourage CEOs to manage earnings in ways which destroy value and take actions to deceive investors (Jensen et al., 2004). Thus, according to Schnatterly (2003) performance-based pay for the board, along with formal cross-company communication and an operational governance, reduces significantly the likelihood of criminal events.
Furthermore, directors once the accounting fraud has been revealed, face labour market penalties. Hoi and Robin (2010) have analysed how executive and non-executive directors are sanctioned, looking to the probability of losing internal board seat and the probability of losing external board seat (outside directorship). As result of the investigation, they found that executive directors, once the accounting fraud is revealed, are twice as likely to lose the seat than the non-executive ones, and five times as likely to lose at least one external board seat.
The board of directors, made up of inside and outside members, could influence the occurrence of an accounting fraud. According to Beasley (1996), when a larger component of outside members is present inside the board, the probability of financial statement fraud is low. Unlike the presence of outside members in the board, the role of general counsel in a firm is related to lower financial reporting quality and more aggressive accounting practices. This is likely to happen when this professional figure is highly remunerated, and entails a limited aggressive behaviour that does not jeopardise their reputation in the firm (Hopkins et al., 2015).
Literature has recently recognised that organizational factors are related to a lack of fraud. In the study of Law (2011), based on hundreds of CFOs’ survey responses in Hong Kong, it is highlighted how audit committee effectiveness, internal audit effectiveness, ethical policies and the tone of the top management team are associated with an absence of fraud.
So, corporate governance is a core topic inside the accounting fraud analysis, due to its influence inside a company’s organization and in the policies chosen. On the other hand, a relationship exists between corporate governance and financial performance, and needs to be well considered in order to avoid fraudulent events. Corporate governance elements could be used to illustrate the path of US banks that led to the 2008 financial crisis, better than loan quality. Indeed, inside financial corporations, factors such as CEO duality, executive incentive pay, or board size had a strong influence on what happened. In fact, board size has a positive influence on financial performance, because with a larger board there is more expertise and it increases the possibility of establishing contacts with new customers. On the other hand, when the board of directors is too large, it risks damaging the board’s capacity of monitoring all processes, and increases agency problems. At the same time, CEO duality is seen as a key driver of agency conflicts. Since the chairman of the board is responsible for monitoring CEO decision-making and overseeing the process of CEO hiring, compensation and firing, combining these two roles in a person would prevent the chairman from controlling CEO activity (Grove et al., 2011).
During recent years, there have been several efforts to reduce accounting fraud and corporate fraud by European countries and the rest of the world. Mostly, after financial scandals (Enron, WorldCom and Parmalat) that shed light on the many loopholes which characterise regulatory systems, states decided that it was time for a change. There have been remarkable corporate law reforms that have improved the mechanism of internal governance and disclosure requirements, and have strengthened public enforcement (Enriques and Volpin, 2007).
Sorensen and Miller (2017) in their analysis, in addition to having studied how the Enron and Parmalat scandals occurred in the U.S.A. and Italy, and their regulatory systems before and after the events, have highlighted the similarities between EU and US legislations. Indeed, after the Enron financial scandal, the United States issued the Serbanes-Oxley Act (2002) which provided most of the governance and audit changes, that nowadays we see in our companies. US and non-US companies listed in the American stock exchange have to comply with the SOX guidelines. So, a European company which had its shares listed in an American stock exchange previously had to follow the European Law and then subsequently, it has to comply with the Serbanes-Oxley Act. Due to this long and expensive process for public companies, and after the Parmalat scandal, the EU decided to reform its Statutory Audit to improve the audit quality and to align with the SOX previsions. In particular, these changes included in Directive 2006/43/EC provide for the establishment of a chain of responsibility in the consolidated entities (audited by more than one firm) and the oversight, in listed companies, of financial reporting process by an audit committee, and other rules which concern mostly the audit company.
In conclusion, the authors believe that without a reform of the private enforcement system, accounting fraud and corporate governance misapplication will not stop.
The Italian government, in order to improve control on accounting reports inside listed companies, introduced with L. 262/2005 (Saving Law) the role of Financial Reporting Manager (also known as “Dirigente Preposto per la redazione dei documenti contabili societari”). The objective of the legislator is to establish a specific governance model, for public companies that are listed in stock markets, which concerns accounting documents and guarantees their trustworthiness.
The Financial Reporting Manager must attach a truthful statement to every document and communication regarding the economic, financial and patrimonial situation of the firm. Therefore, he is obliged to certify all the accounting documents, which come from his office, and that the financial reporting statements correspond to accounting books and data.
This new professional figure is subject to a civil responsibility, and to criminal responsibility too. First, he has a civil responsibility towards whoever could be damaged by a violation of law and the company statute. Then, after the 2005 reform, the legislator has incorporated a financial reporting manager as an active person in the circumstances of accounting and corporate fraud.
The sanctionatory regime in Italy tries to emulate foreign systems, in particular, the American one. For those who commit violations, certifying the statements of periodic reports that do not comply with laws, a financial penalty of one million dollars and a ten-year custodial sentence is foreseen (Rossi, 2006). The Italian legislator, introducing the financial report manager, tried to copy the actions of the U. S. legislator several years before with the Serbanes-Oxley Act (2002), which expanded duties and obligations of CEO and CFO. For example, FRM has same the responsibilities that section n. 302 of SOX gave to CEO and CFO in the certification of the truthfulness of annual and quarterly reports, financial reporting and other accounting data (Pansarella, 2007).
Corporate Governance and Accounting Fraud
Corporate governance is a set of rules, regulations and policies that companies have to comply with in order to avoid fraud and misconduct. States themselves try to establish some controls through a regulatory system. These measures which companies decide to adopt concern, mostly, the organization and the board of directors.
Literature has recently focused on the role that CEOs and managers have in accounting fraud. Troy, Smith and Domino (2011) with their article have analysed how some CEOs could be more inclined to commit fraud than others. In particular, they identified that a specific type of managing director, sharing the same characteristics (young, less functionally experienced and without a business degree), are more likely to rationalize an accounting fraud. Moreover, CEO stock options, a tool commonly used to control managers attitude bonding company’s stock prices and some benefits, do not moderate the relationship between CEO experience and the probability of accounting fraud. The results suggest that there is a direct relationship between stock options and accounting fraud.
On the other hand, research conducted by Armstrong et al. (2010) has shown how there is no evidence making a connection between CEO equity incentives and accounting irregularities. Therefore, the results are more consistent with the notion that equity incentives play a role in aligning managers’ interests with those of shareholders.
At the same time, the remuneration of CEOs has its influence on the occurrence of accounting fraud and on other corporate governance problems. Indeed, equity-based pay plans, traditional pay plans and bonus plans could encourage CEOs to manage earnings in ways which destroy value and take actions to deceive investors (Jensen et al., 2004). Thus, according to Schnatterly (2003) performance-based pay for the board, along with formal cross-company communication and an operational governance, reduces significantly the likelihood of criminal events.
Furthermore, directors once the accounting fraud has been revealed, face labour market penalties. Hoi and Robin (2010) have analysed how executive and non-executive directors are sanctioned, looking to the probability of losing internal board seat and the probability of losing external board seat (outside directorship). As result of the investigation, they found that executive directors, once the accounting fraud is revealed, are twice as likely to lose the seat than the non-executive ones, and five times as likely to lose at least one external board seat.
The board of directors, made up of inside and outside members, could influence the occurrence of an accounting fraud. According to Beasley (1996), when a larger component of outside members is present inside the board, the probability of financial statement fraud is low. Unlike the presence of outside members in the board, the role of general counsel in a firm is related to lower financial reporting quality and more aggressive accounting practices. This is likely to happen when this professional figure is highly remunerated, and entails a limited aggressive behaviour that does not jeopardise their reputation in the firm (Hopkins et al., 2015).
Literature has recently recognised that organizational factors are related to a lack of fraud. In the study of Law (2011), based on hundreds of CFOs’ survey responses in Hong Kong, it is highlighted how audit committee effectiveness, internal audit effectiveness, ethical policies and the tone of the top management team are associated with an absence of fraud.
So, corporate governance is a core topic inside the accounting fraud analysis, due to its influence inside a company’s organization and in the policies chosen. On the other hand, a relationship exists between corporate governance and financial performance, and needs to be well considered in order to avoid fraudulent events. Corporate governance elements could be used to illustrate the path of US banks that led to the 2008 financial crisis, better than loan quality. Indeed, inside financial corporations, factors such as CEO duality, executive incentive pay, or board size had a strong influence on what happened. In fact, board size has a positive influence on financial performance, because with a larger board there is more expertise and it increases the possibility of establishing contacts with new customers. On the other hand, when the board of directors is too large, it risks damaging the board’s capacity of monitoring all processes, and increases agency problems. At the same time, CEO duality is seen as a key driver of agency conflicts. Since the chairman of the board is responsible for monitoring CEO decision-making and overseeing the process of CEO hiring, compensation and firing, combining these two roles in a person would prevent the chairman from controlling CEO activity (Grove et al., 2011).
During recent years, there have been several efforts to reduce accounting fraud and corporate fraud by European countries and the rest of the world. Mostly, after financial scandals (Enron, WorldCom and Parmalat) that shed light on the many loopholes which characterise regulatory systems, states decided that it was time for a change. There have been remarkable corporate law reforms that have improved the mechanism of internal governance and disclosure requirements, and have strengthened public enforcement (Enriques and Volpin, 2007).
Sorensen and Miller (2017) in their analysis, in addition to having studied how the Enron and Parmalat scandals occurred in the U.S.A. and Italy, and their regulatory systems before and after the events, have highlighted the similarities between EU and US legislations. Indeed, after the Enron financial scandal, the United States issued the Serbanes-Oxley Act (2002) which provided most of the governance and audit changes, that nowadays we see in our companies. US and non-US companies listed in the American stock exchange have to comply with the SOX guidelines. So, a European company which had its shares listed in an American stock exchange previously had to follow the European Law and then subsequently, it has to comply with the Serbanes-Oxley Act. Due to this long and expensive process for public companies, and after the Parmalat scandal, the EU decided to reform its Statutory Audit to improve the audit quality and to align with the SOX previsions. In particular, these changes included in Directive 2006/43/EC provide for the establishment of a chain of responsibility in the consolidated entities (audited by more than one firm) and the oversight, in listed companies, of financial reporting process by an audit committee, and other rules which concern mostly the audit company.
In conclusion, the authors believe that without a reform of the private enforcement system, accounting fraud and corporate governance misapplication will not stop.
The Italian government, in order to improve control on accounting reports inside listed companies, introduced with L. 262/2005 (Saving Law) the role of Financial Reporting Manager (also known as “Dirigente Preposto per la redazione dei documenti contabili societari”). The objective of the legislator is to establish a specific governance model, for public companies that are listed in stock markets, which concerns accounting documents and guarantees their trustworthiness.
The Financial Reporting Manager must attach a truthful statement to every document and communication regarding the economic, financial and patrimonial situation of the firm. Therefore, he is obliged to certify all the accounting documents, which come from his office, and that the financial reporting statements correspond to accounting books and data.
This new professional figure is subject to a civil responsibility, and to criminal responsibility too. First, he has a civil responsibility towards whoever could be damaged by a violation of law and the company statute. Then, after the 2005 reform, the legislator has incorporated a financial reporting manager as an active person in the circumstances of accounting and corporate fraud.
The sanctionatory regime in Italy tries to emulate foreign systems, in particular, the American one. For those who commit violations, certifying the statements of periodic reports that do not comply with laws, a financial penalty of one million dollars and a ten-year custodial sentence is foreseen (Rossi, 2006). The Italian legislator, introducing the financial report manager, tried to copy the actions of the U. S. legislator several years before with the Serbanes-Oxley Act (2002), which expanded duties and obligations of CEO and CFO. For example, FRM has same the responsibilities that section n. 302 of SOX gave to CEO and CFO in the certification of the truthfulness of annual and quarterly reports, financial reporting and other accounting data (Pansarella, 2007).
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