The Political Economy of Corporate Fraud: A Theory and Empirical Tests.

Abstract

Guided by a theory governance known as slectrorate theory (Bueno de Mesquita et al,2003), we examine how governance structures within publicly traded companies affects corporate performance, the ease with which corporate executives lose their jobs for poor performance, and the incentives of executives to misstate corporate performance to protect their jobs. Firms are classified according to number of individuals who have a say in who should lead them (the slectorate) and the size of the group of supporters and leaders needs to gain or maintain control (the winning coalition). Using publicly available data, we develop measures of these concepts within the corporate setting and show that these governance structures influence corporate performance and compensation packages used to reward management and stockholders. We compare compensation packages and reported performance with those expected given governance structures. Deviations from expectations provide predictors of fraudulent reporting that allow for discrimination between firms that subsequently commit fraud (within two years) and those that do not.