Financial Misconduct Research Articles

No rose without a thorn: Corporate teamwork culture and financial statement misconduct

This study investigates the dark side of corporate teamwork culture on firms’ financial reporting behaviors. We used a novel corporate culture measurement developed by machine learning approach (Li et al., 2021), and calculated Benford Score (Amiram et al., 2015) as the proxy for financial misconduct in firms’ annual financial statements from 2003 to 2021. We find a positive association between a company’s emphasis on teamwork culture and financial statement misconduct; this association is more pronounced when a firm reports no internal control weakness. Additional analyses show that firms with stronger teamwork cultures are more likely to engage in financial statement misconduct when they use a Big 4 accounting firm as an auditor, or they are smaller in size. This research contributes to the collusive fraud literature by identifying a mechanism by which accounting personnel might be complicit and/or participate in financial statement misconduct or fraud. Our findings may be of interest to those tasked with corporate governance in identifying and preventing financial statement fraud.

Birds of a feather flock together: Institutional investors with disciplinary history and financial reporting

This study examines the role of financial misconduct of institutional investors on financial reporting quality of investee firms. We find that the firms held by institutional investors with disciplinary history (IDH) are more likely to engage in financial misreporting. Our results are not driven by institutional investor characteristics such as activism, incentives to monitor, investment horizon, or portfolio size. The impact of IDH is stronger in the firms that are more likely to engage in financial misreporting (i.e., the firms that barely meet analysts’ expectations and with CEOs with higher career concerns). IDH have stronger impact on financial misreporting when the institution reports multiple disciplinary events, the disciplinary event is recent, or disciplinary action is taken against the institutional investor company rather than just its affiliates. Results continue to hold after implementing various statistical tests to address potential endogeneity issues and alternative measures of financial misreporting.

Voluntarism in partition’s aftermath: the Faridabad story

ABSTRACT This article adopts an alternative framework for thinking about the Nehruvian state and the drivers that shaped India’s postcolonial development strategy. This is a firm shift away from viewing development as a technocratic enterprise, and towards a focus on how the Nehruvian state sought to deploy notions of voluntarism. Within the Indian context, voluntarism referred to the mobilisation of ordinary people to further local development projects. This article investigates voluntarism through efforts at rehabilitating able-bodied refugees in Faridabad. Like many refugee townships that were constructed in the immediate aftermath of Partition, Faridabad was built from the ground up entirely through reskilled able-bodied refugee labour. Within the environment of rehabilitation, the article shows how voluntarism through the cooperative model became an integral postcolonial development strategy adopted by the Nehruvian state to construct new distinct urban spaces on formerly uncultivated lands. However, the article will reveal how the Nehruvian state’s use of voluntarism was beset with tensions, challenges, and problems. The article shows how widespread refugee discontent, bureaucratic mismanagement and alleged financial misconduct ultimately impeded the Nehruvian vision of empowering and mobilising ordinary Indians to further projects of public utility.

Partisan Values and Financial Misconduct

Partisan Values and Financial Misconduct

Investor Reactions to Apologies for Financial Misconduct

Investor Reactions to Apologies for Financial Misconduct

Board diversity and financial reporting quality: does firm size matter?

This study scrutinises how the diversity of a board of directors (BOD) determines the financial reporting quality (FRQ) and how firm size may act in a moderating role. FRQ has two measurments, which are faithful representation and relevance. Faithful representation has one proxy, which is financial restatement. Relevance has two proxies, which are the predictive value and confirmatory value. Moreover, a board’s diversity includes its members’ gender, age, expertise and educational level. The research sample consists of companies listed on the Indonesia Stock Exchange from 2016 to 2020; this produced 377 firms, resulting in 1,885 observations; we used panel data. Boards are homogeneous, except for boards with accounting expertise. Male directors can reduce the potential for financial restatements, but when moderated by firm size, they cannot guarantee the predictive value. Moreover, old directors can also reduce financial misconduct, but unqualified opinions are difficult to obtain when moderated by firm size. Further, a BOD without a member holding a doctoral degree can have a significant adverse effect on financial restatements and agency conflict. Agency conflict is the ultimate result of a negative predictive value. Meanwhile, board expertise boosts the fairness of financial reporting, resulting in obtaining an unqualified opinion and providing a predictive value. The fundamental qualitative characteristics of financial reporting must offer a relevant and faithful representation, while the previous studies employed this separately; this study tackles that gap. The previous research that tested corporate governance on FRQ is still very limited and tends to focus on one topic (e.g. gender), so our research is more comprehensive since BOD diversity was investigated. The FRQ worsens because the BOD is homogeneous. Based on the findings, the FRQ can be improved if there are female directors, younger directors, and directors who hold PhDs serving on the boards. This means that their presence/proportion must increase.

Causes and consequences of flocked resignations of independent directors: Inferences from firm impacts following Kangmei Pharmaceutical's scandal

The monitoring role of independent directors could be compromised by weak legal environments and a lack of law enforcement, especially in emerging markets. We explore this issue by investigating the possible causes and consequences of large-scale resignations of independent directors across Chinese firms following Kangmei Pharmaceutical's financial scandal. We show that those resignations signaled potential problems for respective firms because those companies were more likely to be exposed to financial misconduct and experience poor stock performance. Our evidence suggests that holding independent directors accountable for negligence of duty is an essential component of corporate governance.

The peer effect of penalty against firm leaders

This paper investigates whether and how penalty against firm leaders influences peer firm's financial misconduct. When observing salient penalties against their peers, firms tend to adjust their expected costs related to financial misconduct to a higher level. This will then weaken focal firm leaders’ motivation to commit financial misconduct given their expected benefits from it are determined. By employing a difference-in-differences (DID) method, we find supporting evidence. Further analyses show that this effect is more prominent when observing firms witness severer punishment or they are SOEs.

CEO INCENTIVE ALIGNMENT: INTENSITY AND TIME HORIZON

Incentive design is a key feature of corporate governance and strategic leadership to ensure that CEOs' and shareholders' interests are aligned. A primary focus to date has been on incentive intensity, the strength of the alignment between CEO compensation and firm performance. We examine a new facet, the CEO-incentive time horizon, the degree to which CEO compensation is aligned with performance horizons. After controlling for incentive intensity, we assess positive and negative performance outcomes and find that firms with longer CEO-incentive time horizons exhibit significantly greater total shareholder returns, ROA growth, and reduced financial misconduct. We also find when investor time horizons are longer, and also when information asymmetry between managers and shareholders is higher, relationships between CEO-incentive time horizon and financial misconduct, as well as long-term performance, are stronger. Considering the time horizon in compensation provides a deeper explanation of the relationship between executive incentives and firm performance. "…the efficacy of granting equity to the CEO in order to achieve incentive alignment…is far from settled, leaving unanswered questions regarding the conditions under which incentive alignment mechanisms achieve their intended goal". - Martin, Wiseman, & Gomez-Mejia (2019)

Rule Violation and Time-to-Enforcement in Weak Institutional Environments: A Good Faith Perspective

Previous studies on corporate misconduct have focused mainly on preventing misconduct or remedying it after detection, but it remains unclear how misconduct can be effectively detected in the first place once it occurs. We apply the good faith perspective in the context of China, which represents a weak institutional environment, and argue that the ability of culpable leaders to conceal information may delay misconduct disclosure because such ability helps maintain the good faith of regulators. Moreover, we argue that because the regulators have faith in professionals (external auditors, institutional investors, and securities analysts) whose skills are in fact often underdeveloped in detecting misconduct in weak institutional environments, the impact of managerial concealment on disclosure delay becomes stronger when fraudulent firms are followed by such professionals. Using a sample of Chinese public firms involved in financial misconduct, we find support for these arguments—that is, compartmentalization in governance positions, which enhances culpable leaders’ ability to conceal misconduct, delays public disclosure by regulators. Furthermore, the relationship becomes stronger when the misconduct goes undetected by credible professionals.

Investor Reactions to Corporate Misconduct: The Moderating Role of Firm Reputation

Corporate misconduct research has observed negative market reactions following misconduct. Drawing on signaling theory, this study considers misconduct as a negative signal and links misconduct severity to market reactions. We argue that severity level decides signal strength and increases market reaction magnitude. However, it is unclear why different firms are punished to varying degrees for similar misconduct. We therefore demonstrate how perceptual biases distort investors’ perceived severity and describe how the effect of severity is moderated by firm reputational signals, including moral, technical, and leadership capital. This study is supported by an empirical analysis of 344 Chinese listed firms that engaged in financial misconduct during 2009–2019. Accordingly, we facilitate a more fine-grained understanding of the relationship between corporate misconduct and market reactions.

Janus-faced Effects of Political Connections on Corporate Insider Trading

Whether political connections trigger or inhibit financial misconduct is yet to be concluded. We contend that politically connected firms do evil and good simultaneously. Based on the status attainment perspective, we propose that those firms are Janus-faced in respect of insider trading such that they commit illegal insider trading (substantial misconduct) and voluntarily report the legal insider trading (symbolic compliance) simultaneously. Contextualized in a panel dataset of Chinese private listed firms, we found strong support for Janus-faced effects. Moreover, those organizational substantial misconducts become restrained under a greater stringency of anti-corruption whilst symbolic compliance tends to be stronger given more government subsidies. Overall, the study advances the literature of financial misconduct by unveiling the Janus-faced effects of political connection. It also presents new evidence of the contextualized view of corporate governance while unveiling that government subsidies exacerbate the inclinations of symbolic compliance.

One of These Things is Not Like the Other: How Firms’ Post-Misconduct Actions Differ by Misconduct

To mitigate potential negative consequences of corporate misconduct to the firm, CEO changing of the guard (dismissal and replacement) is commonly used to signal that the firm is remedying the underlying cause of its misconduct. However, scholars have yet to disentangle the outcomes on this type of corrective action in different misconduct contexts. Accordingly, in this study, we theorize the degree of CEO attribution for misconduct, whether it be dispersed or concentrated, helps to better understand differences in firm changing of the guard actions for misconduct. We test our arguments on two misconduct contexts (CEO personal misconduct and firm-level financial misconduct) and find that CEO dismissal and successor type are influenced by misconduct context-attribution type and firm performance moderates these relationships. Thus, we provide a deeper understanding of theory on corporate misconduct and changing of the guard actions.

Women Directors’ Turnover Following Financial Misconduct: What's Social Environment Got to Do with It?

AbstractIn this study, we consider the role of social environment in boards’ decisions whether to replace women directors or not following corporate financial misconduct. To explain the board's decision, two competing hypotheses are presented. The immunity perspective suggests that women directors benefit from growing social pressures to increase women's representation on boards, resulting in a lower turnover, while the susceptibility perspective proposes that societal gender stereotypes that give rise to biased boards’ decisions result in a higher turnover. Using a sample of Chinese firms involved in financial misconduct during 2011–2019, we find strong support for the susceptibility perspective and show a higher turnover of women directors following financial wrongdoing. Further, we find that board gender diversity and a firm's belonging to male‐dominated industries increase women directors’ turnover. Our findings make important contributions to directors’ turnover literature and practice.

Unraveling Financial Fraud: The Role of the Board of Directors and External Advisors in Conducting Independent Internal Investigations*

ABSTRACTAlthough firms are encouraged by the SEC and Department of Justice to conduct internal investigations following financial misconduct, prior research finds few benefits for investigating firms. This study examines a novel aspect of internal investigations—namely, whether the investigation is conducted by independent versus nonindependent teams—and explores the impact of these teams on investigation outcomes. Consistent with our predictions, we find that firms whose internal investigations are led by independent teams are more likely to retain external advisors, have a higher likelihood of CEO turnover, and face a lower likelihood of an SEC enforcement action than do firms whose investigations are led by nonindependent teams. Our findings demonstrate that the SEC grants enforcement leniency to firms that conduct an internal investigation, but this finding only holds when the investigation leader is considered independent. These results also suggest that appointing independent groups to lead internal investigations protects the firm, at the expense of the CEO, following accounting fraud. Our paper has important implications for researchers studying accounting irregularities as we are the first to show that independent board members and external advisors play a direct role in the resolution of financial misconduct through their job on the internal investigation team.

From past lies to current misconduct: The long shadow of China's Great Leap Forward

Using hand-collected data on yield over-reporting during China's Great Leap Forward (GLF) period, we find that GLF over-reporting in a chairperson's province of origin strongly predicts corporate financial misconduct today. Evidence from a variety of identification strategies establishes a causal relationship. We also extend our analyses to other aspects of corporate misconduct and local dishonest behaviors. We show that GLF over-reporting has shifted social norms toward a present-day tolerance for dishonesty. Our findings suggest that wrongdoings by local government officials in the past can lead to adverse effects on people's future behavior in the form of cheating.

Understanding the Corporate Governance Score: Are Some Components of Corporate Governance Overrated? Evidence from a Developing Country

The corporate governance structure of companies has been subjected to intense examination in recent time due mainly to recent corporate collapses and other financial mis-conduct by management. The benefits of an effective corporate governance structure are well documented, ranging from reduce cost of capital to improved transparency in ethics, morality and financial disclosure. Evaluating the effectiveness of a company’s corporate governance structure normally involves the use of a corporate governance score. This study investigates the appropriateness of some of the more commonly used components in compiling the corporate governance score. The study found that the presence of both an audit committee and a compensation committee along with effect of CEO duality had significant statistical effect on the corporate governance score. However, the results also showed that the size of the board and the number of independent directors were not statistically significant components of the corporate governance score.

Not All Types of Social Networks Are Good: The Dual Effects of Social Networks on Courtesy Stigma

ABSTRACTWhen a firm is accused of serious misconduct, its executives, even those who are nonculpable, are stigmatized by the firm's stakeholders, a phenomenon known ascourtesy stigma. One research stream explores how executives’ social networks mitigate courtesy stigma, with an emphasis on the positive effect of social networks. From the perspective of a social network as an information pipe, we suggest that social networks are a double-edged sword in the context of courtesy stigma because of their distinctiveinsulationandexposuremechanisms. Our proposed hypotheses are supported via event history analysis using data collected from a Chinese sample of listed firms that demonstrated financial misconduct in the period 2007–2016. Our study contributes to the literature on social networks and courtesy stigma by revealing their complex links.

The Limits of Sentimentalism: Financial Misconduct, Sensibility and Parliamentary Scandal in the Case of Powell and Bembridge

In the late eighteenth century, the language of sentiment was deployed to justify a wealth of individual behaviours, laudable or otherwise. From illicit desire in Jean‐Jacques Rousseau's Julie to murder in Herbert Croft's Love and Madness, sensibility was, among other things, a tool of exoneration. Using Edmund Burke's appropriation of sentimentalism in the Powell–Bembridge scandal of 1783, this article examines what happens when this well‐worn mechanism fails, when sensibility reaches its limits. Burke's inability to explain away the crimes of these two men with his usual tactics exposes sensibility's ultimate resistance to certain nefarious narratives.

Corporate social responsibility and litigation risk: Evidence from securities class action lawsuits

AbstractThis study examines whether corporate social responsibility (CSR) is associated with the likelihood and outcomes of securities class action lawsuits. We find a lower likelihood of securities litigation for firms with higher CSR. This effect is larger for companies with lower levels of financial distress, companies with larger proportions of institutional investors, and for internal CSR. Additionally, CSR has a mitigating effect on negative market assessments around the filing dates of securities litigation. The results suggest that higher CSR firms are less likely to engage in financial misconduct, and investors are less likely to penalise them for such occurrences.