Monitor or Participant? The Impact of Employee Stock Ownership Plans on Corporate Fraud

Abstract

We examine the impact on corporate fraud of a firm’s adopting an employee stock ownership plan (ESOP) using a sample of Chinese firms. We document that ESOPs promote corporate fraud and inhibit fraud detection. The results are robust after accounting for potential endogeneity, alternative metrics of corporate fraud, and the time from fraud to detection. Additional analysis suggests that the effect is more pronounced for ESOPs that have a short lockup period, a high shareholding ratio, or are near the end of their lockup period, consistent with the notion that ESOPs drive employees’ short-sightedness and induce them to engage in fraud or not report it when they see it. Last, we find the adverse effect of ESOPs on fraud detection is more stringent in firms with weak external monitoring and poor internal control and non-state-owned firms, indicating that ESOPs can weaken employees’ role in monitoring corporate fraud.

Keywords: ESOP, Fraud committing, Fraud detection, Employees' willingness to participate in fraud, Employees' role in monitoring fraud