The dark side of 'good' corporate governance: compliance-fuelled book-cooking activities

Thomas Kirchmaier and Mariano Selvaggi

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We argue on theoretical grounds that obligatory compliance with stricter financial reporting rules (e.g. the US Sabanes-Oxley Act) may entail important unintended consequences. Paradoxically, the amount of misreporting may increase because corporate boards spend more valuable resources fulfilling statutory mandates rather than involving themselves in forward-looking strategy setting, As these surveillance devices are substitute methods of gauging management quality, when boards focus on the firm's internal control and accounting system they become semi-detached from strategy - their business acumen falters. Top executives are then judged primarily on the basis of financial metrics as opposed to long-term fit. Since the balance sheet review carries more weight in the board's decision-making process, the return to managerial book-cooking (a purely influence activity) and the risk of endorsing flawed business plans swell. This confirms a burgeoning sentiment among business leaders and scholars that boards should perhaps pay less rather than more heed to codified, verifiable 'good ' governance principles.

Keywords: corporate governance; earnings manipulation; auditing; misreporting; Sarbanes-oxley act; combined code on corporate governance (search for similar items in EconPapers)
JEL-codes: D23 G30 K20 M21 M40 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2006-04
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