In our paper, Executive Gatekeepers: Useful and Divertible Governance?, which was recently made publicly available on SSRN, we study the role of executive gatekeepers in preventing governance failures, and the counter-incentive effects created by equity compensation. Specifically, we examine the following two questions. First, do executive gatekeepers actually improve governance in the average firm? Second, does the effectiveness of gatekeepers in ensuring compliance and/or reducing corporate misconduct depend on their incentive contracts?
Posts Tagged ‘Corporate fraud’
Traditional models of crime frame the choice to engage in misbehavior like any other economic decision involving cost and benefit tradeoffs. Though somewhat successful when taken to the data, perhaps the theory’s largest embarrassment is its failure to account for the enormous variation in crime rates observed across both time and space. Indeed, as Glaeser, Sacerdote, and Scheinkman (1996) argue, regional variation in demographics, enforcement, and other observables are simply not large enough to explain why, for example, two seemingly identical neighborhoods in the same city have such drastically different crime rates. The answer they propose is simple: social interactions induce positive correlations in the tendency to break rules.
Our mid-year report one year ago presented an exciting opportunity to discuss a time of great change at the SEC. A new Chair and a new Director of Enforcement had recently assumed the reins and begun making bold policy pronouncements. One year later, things have stabilized somewhat. The hot-button issues identified early in the new SEC administration—admissions for settling parties, a growing number of trials (and, for the agency, trial losses), and a renewed focus on public company accounting—remain the leading issues a year later, albeit with some interesting developments.
As the debate continues over whether and how to punish companies for unlawful conduct, U.S. federal prosecutors continue to rely significantly on Non-Prosecution Agreements (“NPAs”) and Deferred Prosecution Agreements (“DPAs”) (collectively, “agreements”). Such agreements have emerged as a flexible alternative to prosecutorial declination, on the one hand, and trials or guilty pleas, on the other. Companies and prosecutors alike rely on NPAs and DPAs to resolve allegations of corporate misconduct while mitigating the collateral consequences that guilty pleas or verdicts can inflict on companies, employees, communities, or the economy. NPAs and DPAs allow prosecutors, without obtaining a criminal conviction, to ensure that corporate wrongdoers receive punishment, including often eye-popping financial penalties, deep reforms to corporate culture through compliance requirements, and independent monitoring or self-reporting arrangements. Although the trend has been robust for more than a decade, Attorney General Eric Holder’s statements in connection with recent prosecutions of financial institutions underscore the dynamic environment in which NPAs and DPAs have evolved.
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) was enacted following the accounting scandals of the early 2000s involving Enron, WorldCom and other public companies. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) in 2010 following the global credit crisis that began a few years earlier. Both statutes offer protections for employees who face retaliation for “blowing the whistle” on corporate misconduct, and Dodd-Frank also provides enhanced monetary incentives to the employees who do so. Given the SEC’s recent and often-stated commitment to strict enforcement of the securities laws, coupled with the fact that the SEC has received over 6,000 whistleblower complaints in the past two years (and has made six awards since inception of its whistleblower reward program in 2011), whistleblowing activity now is a fact of corporate life that is likely to become even more prevalent as awareness spreads of the Dodd-Frank whistleblower reward program.
I have participated in this event for many years and have always considered this conference to be all about the compliance and legal issues that are most important to the integrity of our securities markets. Now, as Chair of the SEC, I would like to thank you for the work you do day in and day out to protect investors and keep our markets robust and safe.
In about a week, I will have completed my first year at the SEC. It has been quite a year. We have made very good progress in accomplishing the initial goals I set to achieve significant traction on our rulemaking agenda arising from the Dodd Frank and JOBS Acts, intensify our review of the structure of our equity markets, and enhance our already strong enforcement program.
Corporate scandals have large negative effects on the value of the firms that are discovered having committed fraud (Karpoff, Lee, and Martin, 2008; Dyck, Morse, and Zingales, 2013). Besides inflicting direct losses to shareholders, corporate fraud may also have indirect effects on households’ willingness to participate in the stock market, which may generate even larger losses by increasing the cost of capital for other firms. Evidence of the externalities generated by corporate fraud, however, is quite limited.
The doctrine of piercing the corporate veil is shrouded in misperception and confusion. On the one hand, courts understand the fact that the corporate form is supposed to be a juridical entity with the characteristic of legal “personhood.” As such courts acknowledge that their equitable authority to pierce the corporate veil is to be exercised “reluctantly” and “cautiously.”  Similarly, courts also recognize that it is perfectly legitimate to create a corporation or other form of limited liability company business organization such as an LLC “for the very purpose of escaping personal liability” for the debts incurred by the enterprise. 
Marked by leadership changes, high-profile trials, and shifting priorities, 2013 was a turning point for the Enforcement Division of the Securities and Exchange Commission (the “SEC” or the “Commission”). While the results of these management and programmatic changes will continue to play out over the next year and beyond, one notable early observation is that we expect an increasingly aggressive enforcement program.
In our paper, Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk, forthcoming in the Journal of Financial Economics, we examine how and why two aspects of top executives’ behavior outside the workplace, as measured by their legal infractions and ownership of luxury goods, are related to the likelihood of future misstated financial statements, including fraud and unintentional material reporting errors. We investigate two potential channels through which executives’ outside behavior is linked to the probability of future misstatements: (1) the executive’s propensity to misreport (hereafter “propensity channel”); and (2) changes in corporate culture (hereafter “culture channel”).