Corporate Fraud, Governance and Auditing
University of Salerno - Centre for Studies in Economics and Finance (CSEF)
University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
February 4, 2009
EFA 2009 Bergen Meetings Paper
We analyze corporate fraud in a model 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 choose auditing quality and the performance sensitivity of managerial pay, taking external corporate governance and auditing regulation into account. For given managerial pay, it is optimal to rely on auditing when external governance is in an intermediate range. When both auditing and incentive pay are used, worse external governance must be balanced by heavier reliance on both of those incentive mechanisms. In designing managerial pay, equity can improve managerial incentives while stock options worsen them.
Number of Pages in PDF File: 40
Keywords: accounting fraud, auditing, managerial compensation, corporate governance, regulation
JEL Classification: G28, K22, M42
Date posted: February 5, 2009 ; Last revised: March 2, 2009
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