Who Blows the Whistle on Corporate Fraud?

by Alexander Dyck, Adair Morse and Luigi Zingales, University of Toronto & University of Chicago.

Published on The American Finance Association, November 12th, 2010.

To identify the most effective mechanisms for detecting corporate fraud we study all reported fraud cases in large U.S. companies between 1996 and 2004. We find that fraud detection does not rely on standard corporate governance actors (investors, SEC, and auditors), but rather takes a village, including several non-traditional players (employees, media, and industry regulators). Differences in access to information, as well as monetary and reputational incentives help to explain this pattern. In-depth analyses suggest that reputational incentives in general are weak, except for journalists in large cases. By contrast, monetary incentives help explain employee whistleblowing.

The large and numerous corporate frauds that emerged in the United States at the onset of the new millennium provoked an immediate legislative response in the Sarbanes-Oxley Act (SOX). This law was predicated upon the idea that the existing institutions designed to uncover fraud had failed, and that their incentives as well as their monitoring should be increased. The political imperative to act quickly prevented any empirical analysis to substantiate the law’s premises. Which actors bring corporate fraud to light? What motivates them? Did reforms target the right actors and change the situation? Can detection be improved in a more cost effective way? (continue reading… )

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