Jain, Juhee
(2022)
DIRECTORS’ COMPENSATION & FINANCIAL STATEMENT FRAUD: A COMPARATIVE STUDY OF CHINA AND THE US.
PhD thesis, University of Nottingham.
Abstract
Financial statement fraud (FSF), generally committed by personnel in high ranks commanding substantial power, is regarded as one of the costliest corporate frauds which has affected both developed and developing nations. One of the reasons for the occurrence of FSF is the divergence in interests of the management (agents) and shareholders (principals). Agency theory propounds implementation of adequate compensation for achieving the alignment of interests of agents and principals. However, compensation is a double-edged sword, which may control or aggravate the incidence of FSF. Existing research has, primarily, focused on earnings management/restatement/FSF and its linkages with executive compensation. However, such analysis does not give a full picture, as directors (acting as agents of shareholders) are key monitors of the management and if they are effective in their monitoring function, then the incidence of FSF can be controlled. Hence, it is imperative that the directors’ interests are well aligned with those of the shareholders. Thus, this research attempts to view the incidence of FSF from the perspective of directors. Herein, an attempt is made to examine the causal relationship between FSF and directors’ compensation and shareholding.
The main objective of this study is to find out if there are any elements within the compensation packages of directors which may induce FSF. Using matched pairs methodology, this study examines the association between directors’ compensation and shareholding and FSF in two of the worlds’ largest economies, China and the US as these two economies are diametrically opposite in their cultural make-up and in their institutional, political, legal, and governance orientation. China is a collectivist society whereas the US is individualistic. US follows the American corporate governance model whereas Chinese corporate governance paradigm is influenced by the German governance system. Further, in US the private sector plays a key role in the corporate sector whereas in China the state owned enterprises (SOEs) are still a dominant player in the corporate sector.
This research contributes to literature on corporate governance, agency theory, institutional theory, and fraud. The results show that stock-based compensation can induce FSF. Directors’ shareholding in China and directors’ stock-based compensation in the US both have a significant positive association with the incidence of FSF, thereby implying that directors’ shareholding and stock-based compensation can induce fraud. This research finding has implications for practice as it questions the packaging of directors’ compensation and provides evidence against the use of stock-based compensation and shareholding for directors. On the governance front, the results indicate that type of auditor, CEO duality, and frequency of board meetings also influence the incidence of FSF. Also, this research also points out that measures of good corporate governance are vital for all economies irrespective of their cultural and governance orientations.
Additionally, the results of this study can be extended to other developed and developing economies operating within the same corporate governance paradigms as that of China and the US.
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