The Telltale Signs of Corporate Fraud

A new working paper (abstract; PDF) by Tanja Artiga Gonzalez, Markus Schmid, and David Yermack looks for the telltale signs of corporate fraud. The paper is called “Smokescreen: How Managers Behave When They Have Something To Hide”:

We study financial reporting and corporate governance in 216 U.S. companies accused of price fixing by antitrust authorities.  We document a range of strategies used by these firms when reporting financial results, including frequent earnings smoothing, segment reclassification, and restatements.  In corporate governance, cartel firms favor outside directors who are likely to be inattentive monitors due to their status as foreign or “busy.” When directors resign, they are often not replaced, and new auditors are rarely engaged.  Cartel managers exercise their stock options faster than managers of other firms.  While our results are based only upon firms engaged in price fixing, we expect that they should apply generally to all companies in which managers seek to conceal poor performance or personal wrongdoing.

The authors are wise to note that these findings aren’t necessarily generalizable, and it is also worth wondering if this method could be applied prophylactically to identify fraud. Note: Yermack is the same man who brought us “Tailspotting: How Disclosure, Stock Prices and Volatility Change When CEOs Fly to Their Vacation Homes.”

Leave A Comment

Comments are moderated and generally will be posted if they are on-topic and not abusive.

 

COMMENTS: 4

View All Comments »
  1. matt says:

    In some models of game theory it assumes that the closer an industry gets to achieving a homogeneous goods, the more likely oligopolies (cartels) are to form.
    I do think that as a companies start to compete only on price it does lesson the need for auditors, because the free market will work to naturally weed out inefficiencies, thus making auditors less and less effective.
    To me it is better to look at legal oligopolies like rural cement mixers, some crop farmers where their are quotas, and my two personal favorites energy and cable vision providers. This is interesting to me because these industries choose to be regulated in order to create an artificially low supply, thus allowing companies to create cartels. These companies would have little need to have internal checks and balances because usually their price increases are passed on to the end consumer, because in many cases of a very high price elasticity of demand.
    Sorry I know this was all over the map, but to summarize.
    Companies only start to form cartels when they can no longer compete on competitive advantages outside of price. This in turn causes the free market to eliminate or greatly reduce the need for auditors, because the company has to run efficiently in order to survive.
    However in the cases where governmental regulations have created a cartel, their is more incentive for individuals to behave in the manner described above to the detriment of the company and the economy as a whole.

    Thumb up 5 Thumb down 1
  2. Franklin Pearce says:

    This sounds like a useful endeavor, however I can see the press getting it wrong and applying the findings across the board.

    Thumb up 0 Thumb down 1
    • matt says:

      Mr. President,
      I agree, based on my understanding of the paper there is a lot of correlation, but not a lot of causation.

      Thumb up 0 Thumb down 0