Labor market consequences of accounting fraud

Abstract

Purpose

This paper aims to examine the research questions: Do executive and non‐executive directors face similar labor market penalties upon revelation of accounting fraud? Are all executive directors treated by markets as a homogenous group? Or, do executive directors who are top managers face stiffer penalties than other executive directors?

Design/methodology/approach

Board membership of incumbent directors in US firms accused of accounting fraud are tracked for three years after the revelation. Two labor market consequences/penalties are considered. Probability of losing internal, own firm board seat is the likelihood that incumbent directors leave the accused firm's board upon accounting fraud revelation. The likelihood of losing at least one external board seat (outside directorship) is also examined. Both univariate tests and multivariate LOGIT regressions are used to conduct the analysis.

Findings

Compared to non‐executive directors, executive directors are more than twice as likely to lose own firm board seat and at least five times as likely to lose at least one outside directorship. Moreover, all executives, top or otherwise, appear to face similar tough penalties.

Research limitation/implications

Accounting fraud is a rare event; this may limit the generality of the findings. Results obtained from a US sample may be applicable to countries with well‐developed capital and labor markets. Results imply that the labor market for directors serves a vital function in the US‐style corporate governance environment; labor market discipline provides at least some incentives for board members, including non‐employee directors and other executive directors, to perform their fiduciary duties.

Originality/value

This is the first study that utilizes a single corporate event to analyze the operation of the labor market across different categories of directors. Also, while studies have examined penalties on top executives there is no evidence that other executives who also serve on the board of the accused firms suffer labor market penalties.

Citation

Hoi, C. and Robin, A. (2010), "Labor market consequences of accounting fraud", Corporate Governance, Vol. 10 No. 3, pp. 321-333. https://doi.org/10.1108/14720701011051947