Download this Paper Open PDF in Browser

Restoring Trust After Fraud: Does Corporate Governance Matter?

43 Pages Posted: 30 Jun 2004  

David B. Farber

Indiana University Kelley School of Business Indianapolis

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2004

Abstract

In this study, I examine the association between the credibility of the financial reporting system and the quality of governance mechanisms. I use a sample of 87 firms identified by the SEC as fraudulently manipulating their financial statements. Consistent with prior research, results indicate that fraud firms have poor governance relative to a control sample in the year prior to fraud detection. Specifically, fraud firms have fewer numbers and percentages of outside board members, fewer audit committee meetings, fewer financial experts on the audit committee, a smaller percentage of Big 4 auditing firms, and a higher percentage of CEOs who are also chairmen of the board of directors. However, the results indicate that fraud firms take actions to improve their governance and that three years after fraud detection these firms have governance characteristics similar to the control firms in terms of the numbers and percentages of outside members on the board, but exceed the control firms in the number of audit committee meetings. I also investigate whether the improved governance influences informed capital market participants. The results indicate that analyst following and institutional holdings do not increase in fraud firms, suggesting that credibility was still a problem for these firms. However, the results also indicate that firms that take actions to improve governance have superior stock price performance, even after controlling for earnings performance. This suggests that governance improvements appear to be valued by investors.

Keywords: Fraud, corporate governance, credible financial reporting, investor trust, agency costs, independent directors, audit committee

JEL Classification: G34, G39, K22, K42, M41, M43

Suggested Citation

Farber, David B., Restoring Trust After Fraud: Does Corporate Governance Matter? (October 4, 2004). Available at SSRN: https://ssrn.com/abstract=485403 or http://dx.doi.org/10.2139/ssrn.485403

David B. Farber (Contact Author)

Indiana University Kelley School of Business Indianapolis ( email )

801 W Michigan Ave
Indianapolis, IN 46202
United States

Paper statistics

Downloads
2,429
Rank
4,022
Abstract Views
8,851