Can Corporate Governance Mechanism Prevent Corporate Fraud?

The word “fraud” was magnified in the business world around the end of 2001 and the beginning of 2002. No one had seen anything like it. Enron, one of the country’s largest energy companies, went bankrupt and took down with it Arthur Andersen, one of the five largest audit and accounting firms in the world. Enron was followed by other accounting scandals such as WorldCom, Tyco, Freddie Mac, and HealthSouth, yet Enron will always be remembered as one of the worst corporate accounting scandals of all time. Enron’s collapse was brought upon by the greed of its corporate hierarchy and how it preyed upon its faithful stockholders and employees who invested so much of their time and money into the company. Enron seemed to portray that the goal of corporate America was to drive up stock prices and get to the peak of the financial mountain by any means necessary. The “Conspiracy of Fools” is a tale of power, crony capitalism, and company greed that lead Enron down the dark road of corporate America.

Following the several financial scandals of the early 2000s involving the former notorious companies such as Enron and WorldCom corporations, the Sarbanes-Oxley Act of 2002 emerged. Indeed, SOX required that every publicly traded company CEO and CFO endorse the accuracy of their organizations financial statements prior to the official release. Obviously, the idea behind this decision is certainly a way to ensure the integrity of the upper management which dismisses the existence fraud on the financial statements. However, a discovery of fraudulent information on certified financial statements is subject to civil liabilities and criminal prosecutions.

Fraudulent, erroneous, and illegal acts committed by a public company, usually at a managerial or executive level, have been a very serious problem for many years and have prompted development of strict and updated regulations, such as the Sarbanes-Oxley Act, in an attempt to prevent these occurrences. Unfortunately, these new or updated regulations are not enough to prevent these acts from happening, thus not alleviating the auditors of their responsibility to detect fraud. Some methods that management and auditors can employ to prevent and detect fraud, errors, and illegal acts are: improving knowledge, improving skills,

In 2001, it struck everybody as odd when a blue chip stock went bankrupt less than a year after it paid its top 5 executives a total of $282.7 million. The stock market is notorious for being seductively tricky; being the sole contributor to the making and breaking of many men. However, this time it was clear that this wasn’t an ordinary unexpected decline. Enron Corporation, a former American energy company, had to have had something going on behind the scenes to cause the largest chapter 11 bankruptcy of its time. As the house of cards collapsed, it became clear that investors were blindsided by one of the largest instances of pump and dump stock fraud the market had ever seen.

Financial statement fraud is any intentional or grossly negligent violation of generally accounting principles (GAAP) that is undisclosed and materially effects any financial statement. Fraud can take many forms, including hiding both bad and god news. Research shows that financial statement fraud us relatively more likely to occur in companies with assets of less than $100 million, with earnings problems, and with loose governance structures (Hopwood, Leiner, & Young, 2011).

143). Nearly all individuals and organizations are subject to pressure and rationalization of actions, the risk of fraud is great if internal controls are non-existent or can be overridden. It is vital to look-out for indicators that signal weakness in internal control environment. Opportunities exist for fraud due to role of process owners in the structure of internal control and the ability to avoid or override the existing controls (Golden, Skalak & Clayton, 2006 p. 134). Lack of sound corporate governance functions such as inadequacy in the extent and effectiveness of supervision by independent functions are al signals of fraud as it’s a demonstration of weak control environment. The control environment includes the continuity and effectiveness of internal audit, information technology, and accounting personnel as well as the effectiveness of accounting and reporting systems (Golden, Skalak & Clayton, 2006 p. 134). When such deficiencies are not managed or disciplinary actions put in place to check such weaknesses or override of controls, it may signal potential red

People often question whether corporate boards matter because their day-today impact is difficult to observe. But, when things go wrong, they can become the center of attention. Certainly this was true of the Enron, Worldcom, and Parmalat scandals. The directors of Enron and Worldcom, in particular, were held liable for the fraud that occurred: Enron directors had to pay $168 million to investor plaintiffs, of which $13 million was out of pocket (not covered by insurance); and Worldcom directors had to pay $36 million, of which $18 million was out of pocket. As a consequence of these scandals and ongoing concerns about corporate governance, boards have been at the center of the policy

The regulators, SEC, U.S. GAAP, SOX of 2002, together with AICPA, PCAOB, and COSO concentrate on fraudulent reporting mechanisms and ways to lessen its occurrence. Inventors, public, and officials expect auditors detecting fraud to protect third parties interests. The auditors’ core responsibility is to confirm that financial statements are prepared fairly in accordance with U.S. GAAP. Therefore, auditors should comprehend real-world techniques to identify financial statement manipulation.

The purpose of this paper is to highlight the role of external auditing in promoting good corporate governance. The role of auditors has been emphasized after the pass of the Sarbanes-Oxley Act as a response to the accounting scandal of Enron. Even though auditors are hired and paid by the company, their role is not to represent or act in favor of the company, but to watch and investigate the company’s financials to protect the public from any material misstatements that can affect their decisions. As part of this role, the auditors assess the level of the company’s adherence to its own code of ethics.

Enron, a multinational company avoided showing their true financial statements for several years with the help of their auditor. Arthur Anderson, the company’s auditor signed off on the validity of the company’s accounts despite the inaccuracies in the financial statements (Accounting ethics, 2011, para. 12). As a result of Arthur Anderson engaging in unethical practices, Enron’s shareholders lost their money when the company went into bankruptcy, Arthur Andersen employees lost their jobs, and the company went out of business (Accounting ethics, 2011, para. 12). Another example is Adelphia founder, and former CEO John Rigas. He was found guilty of looting Adelphia in 2005. (Mallor, Barnes, Bowers, & Langvardt, 2010). Rigas, along with his son, and CFO Scott, was accused of using the company as their on private ATM to provide fifty million dollars in cash advances, buy 1.6 billion in securities, and repay 252 million in margin loans. As a result of their crimes Rigs received fifteen years in prison, and his son, and former CFO Scott, received twenty years in prison (Mallor et al., 2010).

Financial reporting frauds and earnings manipulation have attracted high profile attention recently. There have been several cases by businesses of what appears to be financial statement fraud, which have been undetected by the auditors. In this thesis, the main purpose is to identify some of the reasons why auditors have not detected financial statement fraud and to suggest possible

The association between corporate governance and financial reporting quality is a fundamental topic in accounting research. Corporate governance is defined as the set of internal and external monitoring mechanisms designed to mitigate the agency costs inherent in the corporate form of ownership (Jensen and Meckling 1976). Financial reporting quality refers to the accuracy and precision with which financial statements convey information about a firm’s operations (Biddle et al. 2009). Previous studies use various indicators of financial misreporting (such as restatements, discretionary accruals, and Securities and Exchange Commission (SEC) enforcement releases) as proxies for financial reporting quality (Dechow et el. 2010). These studies

According to Mitric, Stankovic, and Lakicevic, (2012) financial fraud and embezzlement are clearly two distinct configuration, however share several common characteristics and qualities. Mitric et al. also indicated that company top executives and managers or owners normally are responsible for putting its own company in financial troubles and damaging its organization’s reputation (p.44).

Corporate scandals and accusations of fraud have amplified intensely over the last decade. The cost of fraud has reached over $400 billion dollars a year, not to mention the loss of investments and jobs. Corporation fraud involves creative, complex methods in which to overstate revenues, understate expenses, over value assets, and underreport liabilities. To hide financial problems, management will manipulate stock prices, minimize taxable income, and maximize compensation. “It 's been my experience… that the past always has a way of returning. Those who don 't learn, or can 't remember it, are doomed to repeat it” (Berry, p. 417, 2009). Enron Corporation, WorldCom, Incorporated, and Global Crossing Limited all claimed bankruptcy

There are various measures they can take in order to see that the fraud or the misconduct does not happen in the future. They have to assess the risks and design protocols, then implement the policies as per the plan and evaluate the amount of damage is done to the company and its shareholders. Bill Witherell also focused on this and he commented that “Achieving good corporate governance is not solely the responsibility of the directors, inventors and regulators; it should be a core objective of senior management. Poor corporate governance weakens a company’s potential and at worse can pave the way for financial difficulties and even fraud.”