Corporate fraud and external social connectedness of independent directors

Yu Flora Kuang, Gladys Lee

Research output: Contribution to journalArticleResearchpeer-review

52 Citations (Scopus)

Abstract

We examine the effects of independent directors' external social connectedness on corporate fraud commission and detection. The results show that well-connected independent directors do not affect the likelihood of fraud commission but significantly reduce the likelihood of fraud detection given occurrence of a fraud. In particular, with a one-standard-deviation increase in independent directors' connectedness, the likelihood of fraud detection reduces by 22.5%. We also find that the consequences of fraud commission faced by firms with well-connected independent directors are less severe as fraud remains undetected for a longer period of time and fewer people are charged with fraud when independent directors are well connected. We further show that independent directors' connections to fraud firms significantly increase a firm's propensity to fraud commission and the likelihood of fraud detection is also higher. Overall, our results suggest that directors' personal networks have a “dark side”. Regulators should be aware of unintended consequences associated with directors' external social connections when considering how to prevent and detect corporate fraud.

Original languageEnglish
Pages (from-to)401-427
Number of pages27
JournalJournal of Corporate Finance
Volume45
DOIs
Publication statusPublished - Aug 2017
Externally publishedYes

Keywords

  • Corporate governance
  • Fraud commission
  • Fraud detection
  • Social connectedness

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