Can Corporate Governance Mechanism Prevent Corporate Fraud?
This paper will reviews the extent to which corporate governance acts as efficient tool to protect investors against corporate fraud, thus contributing to summarize the literatures on role of corporate governance on preventing occurrence of corporate fraud. In a more recent study, corporate fraud is part of earnings manipulation done outside the law and standards. Whereas, the activities covered by the terms earnings management (such as income smoothing and big bath) and creative accounting (or window dressing) normally remain within the regulations. In this regard, corporate governance mechanism, particularly effective boards, audit committees, and auditors, decrease the likelihood of corporate fraud occurs. At very last contemplation, vigilant structure within corporation as holding stakeholders interests with shift in ethics and values will likely stop greedy executives to take personal advantages.
Keywords: Corporate fraud, earnings management, corporate governance, board effectiveness, audit committee effectiveness and auditor effectiveness.
There are a number of legal cases involving the accounting manipulation in leading companies in the United States of America (USA) and also other countries, such as Enron and WorldCom in USA, and HIH Insurance and One.Tel in Australia. These have led investors, regulators, and academics to focus on improving dimension of corporate governance to unveil that unethical financial reporting practice. Scholars commonly attribute that poor corporate governance in such companies caused their earnings manipulation. For instance, Lavelle (2002) asserts that Enron’s bankruptcy was caused by the audit committee’s lack of independence, which determined from poor governance, which is part of corporate governance mechanism.
This paper will reviews the extent to which corporate governance acts as efficient tool to protect investors against corporate fraud, thus contributing to summarize the literatures on role of corporate governance on preventing occurrence of corporate fraud. In addition, from the practical point of view, this paper is expected to provide information on how board and audit committee, auditor and regulator indicate and anticipate which firm’s corporate governance mechanism that cause the likelihood to fail to prevent commit corporate fraud and loose stakeholders.
In general discussion, corporate governance mechanism assures a crucial role in improving the efficiency of capital market through its impact on corporate operating efficiency and effectiveness, sustainable growth, and integrity and quality of financial report. Blue Ribbon Committee (1999) asserts good governance promotes relationship of accountability among primary corporation participants to enhance corporate performance. This mechanism holds management accountable to the board and the board accountable to stockholders. The key element of board oversight is working with corporation management to achieve corporate legal and ethical compliance. Board oversight mechanism can be taken in place to deter fraud, anticipate financial risk, and promote high quality, accurate, and timely disclosure to the board, to the public market and to the shareholders.
This paper is organized as follows. In the next section, it will be presented the literature review regarding the corporate fraud and earnings management. It is continued by discussing the effectiveness of board oversight and audit committee, role of external auditor and closing thoughts at curbing fraud.
2. Fraud and Earnings Management
In this section, it will be distinguished between corporate frauds from earnings management. Existing literatures seem no clear agreement on differentiating both those two event in corporate reporting.
2.1 What is Corporate Fraud?
In the beginning of 2000s, US investors has been hit by...