Who blows the whistle on corporate fraud?

Alexander Dyck, Adair Morse, Luigi Zingales, Mon, 02/19/2007



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 created with the idea that the existing institutions designed to uncover fraud - the auditors - had failed, and their incentives as well as their monitoring should be increased. Which actors play a role in deterring corporate fraud through detection? What motivates them? Did reforms target the right actors and change the situation? Can detection be improved in a more cost effective way?

To answer these questions, CEPR DP6126 studies in-depth all reported cases of corporate fraud in companies with more than $750m dollars in assets between 1996 and 2004. The authors find that fraud detection does not rely on one single mechanism, but on a wide range of, often improbable, actors. Only 6% of the frauds are revealed by the SEC and 14% by the auditors. More important monitors are media (14%), industry regulators (16%), and employees (19%). Before SOX, only 35% of the cases were discovered by actors with an explicit mandate. Fraud, therefore, tends to be revealed by people who find out about it in their normal course of business and do not have any strong incentive to reveal it. For example, in sectors like healthcare where qui tam suits are possible and thus whistleblowers are rewarded, employees play a bigger role than investigators in revealing fraud.

After SOX, the performance of mandated actors improved, but still account for only slightly more than 50% of the cases. The paper finds that monetary incentives for detection in frauds against the government influence detection without increasing frivolous suits, suggesting gains from extending such incentives to corporate fraud more generally.

DP6126 Who Blows the Whistle on Corporate Fraud?

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URL:  http://www.cepr.org/DP6126

Topics:  Microeconomic regulation

Tags:  coporate fraud, auditors, Sarbanes Oxley Act


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