Does Fraud Experience Make Directors Better Monitors? The Effect of Fraud Experience on Firm Fraud

Abstract

While past theory and research has highlighted the damaging effect that being involved in a fraudulent event can have on a director’s reputation and future board prospects, in the current study we examine whether serving on a board through a fraud event provides directors with experience that proves to be highly beneficial for the subsequent boards on which they serve. That is, we propose that fraud experience equips directors with requisite expertise to be an effective monitor with respect to preventing fraud at the firms at which they serve in the future. As such, we predict that the presence of fraud-experienced directors on firms’ boards is related to a lower likelihood of fraud occurring at such firms as compared to firms without such directors on their boards. We tested our hypothesis on a sample of firms who had committed fraud (‘fraud firms’) matched with similar peers who had not committed fraud (non-fraud firms) during the study period of 2010-2019.