An Empirical Analysis of the Relation between the Board of Director Composition and Financial Statement Fraud

TLDR

The study tests whether a higher proportion of outside board members reduces financial statement fraud. Results show that firms with more outside, grey, and independent directors, higher outside director ownership and tenure, and fewer outside directorships in other firms have lower fraud risk, while audit committees have no effect.

Abstract

This study empirically tests the prediction that the inclusion of larger proportions of outside members on the board of directors significantly reduces the likelihood of financial statement fraud. Results from logit regression analysis of 75 fraud and 75 no-fraud firms indicate that no- fraud firms have boards with significantly higher percentages of outside members than fraud firms. Results are not sensitive to the definition of outside directors used, given that no-fraud firms have significantly higher percentages of both grey and independent directors than fraud firms. Interestingly, the presence of an audit committee does not significantly affect the likelihood of financial statement fraud. Additionally, as outside director ownership in the firm and outside director tenure on the board increase and as the number of outside directorships in other firms held by outside directors decreases, the likelihood of financial statement fraud decreases.