12. “The relation between accounting frauds and corporate governance systems: an analysis of recent scandals”

Recent sensational evidence on accounting irregularities and frauds has shown how corporate governance systems in modern economies are far from preventing the risk of misleading financial information. The well-known financial scandals show how managers have too often been relatively free to trigger different abuses. Consequently, the failure in preventing and discovering accounting irregularities exposes firms to a dangerous lack of reliability on the markets. Proposed interventions are focused on auditing improvements and fines adjustments to deter incorrect behaviours and stimulate good corporate governance practice. Obviously, no legal, accounting standard and governance system can eliminate the intrinsic relativity and subjectivity of accounting estimates. Nevertheless, the accounting survey discretion cannot be adopted as an excuse for accounting irregularities and good regulation can effectively restrict the risk of accounting irregularities. This paper has the purpose to study the main features of some well-known accounting frauds (about 20), either from the italian or from international evidence, in order to find some relations between corporate governance systems, accounting regulation and the typology of frauds. Frauds are classified according to the following features: - origin, causes and incentives; - development process of the fraud; - implementation tools (i.e. contrast with accounting standards); - people involved. After defining a grid of accounting irregularities main features, we use it to analyse the single specific fraud cases. The purpose is to find, with a qualitative analysis, the more significant differences in accounting fraud typologies and to check the relation between these different typologies and corporate governance systems (accounting regulations, company laws, auditing and control systems, …). We define three classes of corporate governance systems, depending on ownership structure: 1) the “privately controlled” company, in which there is one shareholder, or one group of shareholders who strictly owns the absolute or relative majority of shares; 2) the “open ownership” company, in which there are some shareholders with significant influence, but none of them by itself owns the control of the company; 3) the “public” company, in which no single shareholder have a significant influence. We define two typologies of accounting frauds: - the “excessive power” accounting fraud; - the “performance stress” accounting fraud. More deeply, each specific case of accounting irregularity will be analysed through the following grid of main features: Origin, causes and incentives  Accounting irregularities causes and incentives (“excessive decisional power”, “performance stress”, …);  Accounting irregularities effects on firms results (increasing/decreasing results);  Purpose and interests pursued with accounting irregularities (meet bondholders and/or shareholders expectations, influence financiers decisions, …); Development Process  Time extension of frauds implementation;  Growth of fraud dimension over time. Implementation tools  Items subject to manipulation;  Typologies of accounting tools for irregularities implementation;  The attitude of openly violating or just eluding rules and accounting standard. People involved  Authors and inspirers of the irregularity;  External Auditors effectiveness and role;  Internal auditing effectiveness and role;  Ownership and management decision-making rules. The final purpose of the whole research is to identify the relation between frauds characteristics, economic and legal systems and corporate governance practices in different countries. The comparative analysis of fraud development in different legal and economic environments highlights the effects of contest variables, regulation and control systems on the genesis and development of accounting fraud. This is a working paper in which we look for the empirical relevance of the following hypothesis: • hypothesis A: accounting frauds follow two main generation processes and can be tentatively distinguished in two categories: “excessive power” and “performance stress” accounting frauds; • hypothesis B: corporate governance system has a significant influence in determining the typology of accounting fraud. Our results shows that both hypothesis seem to be quite relevant. Further implementation of our analysis could then relate: - to the extension of the analysis to more cases in an extended time horizon; - to a more detailed definition of the characteristics of the accounting fraud models; - to the use of a more sophisticated quantitative methodology of treating the available data; - to a deep analysis of the role of controlling bodies, regulation and context variables.