The Effect of Corporate Governance Reform on Financial Reporting Fraud

Abstract:     
In response to financial reporting scandals revealed in the early 2000s, Congress and the securities exchanges mandated that boards and audit committees become more independent and banned the provision of most non-audit services to audit clients. Supporters argued these changes would reduce financial reporting fraud, while critics contended the changes were largely window dressing. We examine whether these reforms were successful by comparing changes in the rate of financial reporting fraud for firms that were forced to change their governance structure to that of firms that were already in compliance upon enactment. We find that forcing firms to increase overall board independence significantly reduced the rate of financial reporting fraud, while forcing firms to adopt a fully independent audit committee had a weaker effect. Further, we find that banning non-audit services had no effect in reducing the rate of financial reporting fraud.

Number of Pages in PDF File: 49

Keywords: Sarbanes-Oxley Act, SOX, Corporate Governance, Fraud

JEL Classification: K22, M41, M48

working papers series