March 07
Who Blows the Whistle on
Corporate Fraud?
Transparency and Corporate
Governance
Corporate Law Reforms in Europe: The Two-Tier Model and the One-Tier Model of
Corporate Governance in the Italian Reform of Corporate Law
Capital Market
Reactions to Option Backdating Probes |
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Academic Roundup
Manifest-I presents a summary of recently released academic papers on international corporate governance
and corporate social responsibility issues.
Who Blows the Whistle on Corporate Fraud?
Alexander Dyck, University of Toronto; Adair Morse, University of Michigan;
and Luigi Zingales. National Bureau of Economic Research Working Paper 12882.
The US Securities and Exchange Commission (SEC) and auditors are not the most
important mechanisms in uncovering fraud at US companies, being responsible for
only 6% and 14% of detections respectively, this paper has found. The authors
examined the question of what external control mechanisms are most effective in
detecting fraud, examining all reported cases at companies with more than $750m
in assets between 1996 and 2004. They discovered that equally or more important
monitors of corporate fraud are the media (14%), industry regulators (16%), and
employees (19%).
However, the paper did discover that the Sarbanes-Oxley legislation has
increased the fraud-detection performance of actors with a specific mandate,
rising from them uncovering 35% of cases to 50%.
The conclusion the authors draw from this is that an effective corporate
governance system relies on a complex web of actors, and therefore governance
failures abroad cannot be easily solved by introducing US institutions such as
class action lawsuits or the SEC. Fraud, find the author, tends to be revealed
by people who discover it during the normal course of their business and do not
have any strong disincentive – or even have some positive incentive – to reveal
it.
Transparency and Corporate Governance
Benjamin Hermalin, University of California, Berkeley - Haas School of
Business and Michael Weisbach, University of Illinois at Urbana-Champaign;
National Bureau of Economic Research.
The authors tackle the assumption that increased transparency brought about as a
result of corporate governance reforms is unambiguously good. It is argued that
transparency has both costs and benefits, and there is an optimal level beyond
which increasing transparency lowers profits. Benefits because access to
improved information about performance allows boards to better monitor chief
executive performance; costs because executives must be compensated for the
increased risk that accompanies higher disclosure. Indeed, it is suggested that
transparency reforms have the potential to reduce profits, raise executive pay
and inefficiently increase the rate of chief executive turnover.
Furthermore, it is argued, greater transparency increases managerial incentives
to distort information. The circumstances in which this is most likely to occur
between board and chief executive, the paper suggests, is when the relationship
is most adversarial – and therefore the very cases were board monitoring is
likely to be most important.
Corporate Law Reforms in Europe: The Two-Tier Model and the One-Tier Model of
Corporate Governance in the Italian Reform of Corporate Law
Federico Ghezzi and Corrado Malberti, Bocconi University. Bocconi Legal
Studies Research Paper Series No. 15.
The Italian corporate governance reforms of 2003 for the first time allowed
companies to choose between three different models of governance: the
traditional, and still most common, Italian system that has been modernised by
reform of corporate law; the two-tier system, which owes its basic structure to
the German tradition; and an Anglo-American-style one-tier model. The authors
explore how these models have been implemented in practice, discuss criticisms
of the reforms, and examine the response of Italian companies.
The paper argues that Italy has taken an innovative approach to corporate
governance that may be useful for all European countries interested in granting
companies the power to choose between governance structures. However, the
authors add that, even if courageous, the reforms have not so far been
particularly successful in attracting companies to the new models.
Capital Market
Reactions to Option Backdating Probes
Sakshi Jain and Zabihollah Rezaee
Companies implicated in the
stock options backdating scandal are being punished by the market, this paper
has discovered. The authors examined 180 implicated companies and detected,
overall, significantly abnormal returns around the backdating probe announcement
dates of implicated companies. However, not all companies were found to suffer
equally: the market reaction is more negative for companies with, for instance,
poor corporate governance that has led to shareholder lawsuits or the departure
of executives. The coefficients on corporate governance variables were negative
and statistically significant, and the authors interpret this last finding as
suggesting that capital markets consider ineffectiveness in corporate governance
a serious problem for implicated companies.
March 2007
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