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ers. Such costs include regulatoryand court-imposed penalties and penaltiesimposed by the product and capital markets as aconsequence of loss ofreputation. Reputationalcosts associated with fraud arise from loss of business
and/or a fall in the company’s stock pricebecause of expectations that the company will commitfurther fraud. Given the well-documented
costs incurred by companies accused of corporatefraud, one would expect that these companieswould enhance their internal control systems to
lower the probability of future fraud. Suchenhancements at the board level could also https://www.51lunwen.orghelprepair the company’s reputation and restore confidencein the company.Dalia Marciukaityte is assistant professor of economicsand finance at Louisiana Tech University, Ruston. SamuelH. Szewczyk is associate professor of finance atDrexel University, Philadelphia. Hatice Uzun is assistantprofessor of finance at Long Island University,Brooklyn Campus, New York. Raj Varma is professor offinance at the University of Delaware, Newark.T
Governance and Performance Changes after Accusations of Corporate Fraud
May/June 2006 www.cfapubs.org 33
In the study reported here, we examinedwhether the costs of corporate fraud produce alterationsin the accused company’s internal controlsystem as evidenced by changes in the structure ofthe board of directors and its oversight committees.Specifically, we examined whether the proportionof outside directors—as well as the independence ofthe board’s committees—increases after the revelationor allegation of fraud. Our investigation wasmotivated partly by the scant attention that changesin board structure after the accusation or revelationof fraud have received from academics. In a studyof companies that were accused of a broad varietyof frauds, Agrawal, Jaffe, and Karpoff (1999) examined
performance and director turnover after theaccusation, but they were unable to investigatechanges in board structure because their data source
(Standard & Poor’s Register of Corporations) does notreport such important director characteristics asdirector independence and committee membership.In contrast, we obtained our governance data from
proxy statements that provided rich detail on thecompanies’ boards.
In a study similar to ours, Farber (2005) investigatedchanges in board structure after financialreporting fraud. We examined companies that
were accused of a broader range of frauds than inthe Farber study, including fraud of stakeholders,fraud of the government, financial reporting fraudand regulatory violations. In addition, we compared
the impact of court-imposed costs with theimpact of market-based reputational costs in inducingpositive changes in corporate boards.
We also compared the long-term financial andoperating performance of “fraud companies” withthe performance of a matched sample of comparable“no-fraud” companies. On the one hand, if the cost
of fraud induces fraud companies to bring theirinternal control systems to the level of no-fraudcompanies, we expected to find comparable longrunperformance betweenfraud companies andtheir no-fraud counterparts. On the other hand, ifmarket participants perceive changes in board structuresat companies accused of committing fraud
simply as “window-dressing” arrangements or ifreputation once lost cannot be easily regained, weexpected fraud companies to underperform the
matched companies over the long run.Fraud-Company Database
We constructed