Fraudulent financial reporting detection: Corporate governance red flags

Abstract

The recent fraudulent financial reporting by Enron, Qwest, and other companies was facilitated by poor corporate governance. As shown in this paper, ten timeless factors of corporate governance helped detect such reporting. Weak corporate governance facilitated both classic and recent financial reporting frauds, particularly the following factors: all-powerful CEO, weak system of internal control, focus on short-term performance goals, weak or non-existent code of ethics, and questionable business strategies with opaque disclosures. These factors implied ineffective boards of directors and audit committees. New corporate governance guidelines for boards and audit committees by the U.S. stock exchanges and the Sarbanes-Oxley Act appear to have good potential for strengthening corporate governance to help prevent earnings manipulations and fraudulent financial reporting. These new regulations should continue to strengthen strong corporate governance and control systems, especially in relation to the ten timeless factors for fraudulent financial reporting. If corporate governance guidelines are not followed, then, these stock exchanges can delist the offending companies