Corporate Governance Spillovers

Abstract

Failures of corporate governance at one firm spill over into short-termism and incentives for managers at other firms to manipulate earnings fraudulently due to career concerns and relative performance evaluation. The model predicts that (i) peer governance matters and that the average rate of earnings fraud should be higher when peer governance is weaker; (ii) managers should react more aggressively to changes in relative performance when peer governance is weaker; and (iii) earnings fraud should be most sensitive to peer governance when career concerns are strong. Using data on event-periods associated with fraudulent restatements, I find evidence corroborating all three predictions and the implication that a few bad apples can lead to increased misbehavior at other firms. By studying a specific managerial action, the paper highlights the importance of the role of career concerns and implicit incentives as well as the governance environment in influencing managerial behavior.