کلاهبرداری مالی، اعتبار مدیر، و ثروت سهامداران

We investigate the reputational impact of financial fraud for outside directors based on a sample of firms facing shareholder class action lawsuits. Following a financial fraud lawsuit, outside directors do not face abnormal turnover on the board of the sued firm but experience a significant decline in other board seats held. This decline in other directorships is greater for more severe allegations of fraud and when the outside director bears greater responsibility for monitoring fraud. Interlocked firms that share directors with the sued firm also exhibit valuation declines at the lawsuit filing. Fraud-affiliated directors are more likely to lose directorships at firms with stronger corporate governance and their departure is associated with valuation increases for these firms.

The recent wave of corporate financial scandals has raised substantial concerns about the effectiveness of corporate governance in the US. A commonly held view is that financial scandals are symptomatic of, and result from, massive deficiencies in corporate governance. This view has prompted widespread changes, including the Sarbanes-Oxley Act, new Securities and Exchange Commission (SEC) regulations, and governance requirements adopted by the NYSE and NASDAQ. Additionally, organizations such as Institutional Shareholder Services, the Council of Institutional Investors, and The Corporate Library, among many others, have been actively promoting extensive agendas aimed at reforming the quality of corporate governance in public corporations. There is broad agreement that financial fraud leads to significant valuation losses for investors, as has been apparent in numerous recent governance failures. These losses appear to result primarily from reputational costs borne by firms as a result of the financial fraud. However, relatively little is known about the reputational costs for outside directors of firms that are involved in fraud and the penalties suffered by these directors. In this paper, we examine the role of reputation in the market for directorships as an incentive mechanism for monitoring fraudulent behavior. Until the recent settlements in which outside directors at Enron and WorldCom personally paid over $10 million, outside directors appear to face few consequences for preventing financial misconduct. In this paper, we study whether outside directors suffer reputational penalties if the firms they serve on were accused of financial fraud. We study a sample of firms facing shareholder class action lawsuits alleging financial misrepresentation under rule 10(b)-5 of the 1934 Securities and Exchange Commission Act. We find no evidence of abnormal turnover of outside directors on the boards of sued firms following such lawsuits. However, there is a dramatic decline in the other directorships held by these outside directors. On average, outside directors of sued firms experience a reduction of about 50% in the number of other directorships held, and 96% of outside directors who sit on another board lose at least one directorship within three years following the lawsuit. The reductions in directorships are greater for more serious cases of alleged fraud, as measured by subsequent SEC enforcement actions or settlement amounts following the lawsuit. We study three hypotheses to understand the reduction in directorships following class action lawsuits. The reputation hypothesis holds that outside directors bear personal costs in the form of fewer board seats if their firms are involved in financial misconduct. An alternative (but not mutually exclusive) hypothesis is that the structure and composition of boards is determined endogenously to reflect the monitoring and operating environment. According to this endogenous board hypothesis, a lawsuit can signal that a firm is in a fraud-prone environment, leading its outside directors to spend more time monitoring this firm and to cut back on their other board seats. Finally, we consider the legal liability hypothesis which posits that outside directors cut back on board seats following a lawsuit in an attempt to minimize their future legal exposure. We conduct several tests to explore these hypotheses. We examine how news of a lawsuit affects other firms that are linked to the outside directors of sued firms (i.e., director-interlocked firms). We find that interlocked firms experience significant negative abnormal returns at the time of the lawsuit filing, a finding consistent with all three of the hypotheses that we study. We uncover support for the endogenous board hypothesis when we examine the probability that a firm faces a financial fraud lawsuit. In a simultaneous equations framework, we find that firms most prone to a fraud lawsuit are also more likely to have an outside director who has been previously sued for fraud. This result points to the endogeneity of corporate board composition with respect to fraud likelihood. However, we also find that the presence of sued directors increases the probability of a fraud lawsuit, a finding consistent with the reputation hypothesis which holds that such directors have weaker reputations for monitoring. To understand why directorships are lost by sued directors, we study patterns of departures of sued directors from boards of interlocked firms. Sued outside directors are more likely to lose directorships at interlocked firms that face a higher probability of being sued for financial fraud. This suggests that the decline in directorships is partially driven by the desire of outside directors to reduce their future legal exposure. Sued outside directors are also more likely to depart firms with strong corporate governance, as measured by the Gompers, Ishii, and Metrick (2003) score. In an event-study analysis, we find that announcements of departures of fraud-associated outside directors from boards of director-interlocked firms are viewed positively by investors. Overall, our evidence is most supportive of the reputation hypothesis, but we also uncover evidence in support of the endogeneity and legal liability hypotheses. Irrespective of which hypothesis best explains the decline in outside directorships, our results illustrate that outside directors of firms accused of fraud bear a financial penalty. To the extent that directors optimize the cost-benefit tradeoff of serving on a corporate board prior to the lawsuit, the reduction in directorships indicates that the welfare of these outside directors is reduced following the lawsuit. We estimate the direct financial value of a lost directorship to be approximately $1 million. Our findings are relevant to the current debate on the role of directors in financial fraud. For example, Section 305 of the Sarbanes-Oxley Act grants the SEC with powers to ban directors from sitting on corporate boards if they violate the fraud rules of Section 10(b) of the 1934 SEC Act. Our results suggest that the benefits of such regulation might be more limited than expected since outside director turnover on other boards displays a high sensitivity to the reputational capital of directors. The paper proceeds as follows. Section 2 reviews the relevant literature and presents our research questions. Section 3 describes our data, explains the sample selection process, and presents event-study results for firms facing financial fraud lawsuits. Section 4 examines the effect of financial fraud on director reputation.1Section 5 studies the effect of the class action lawsuit on other firms interlocked through shared directors. Section 6 investigates the probability of retaining directorships following the lawsuit and examines investor reactions to departures of outside directors who sit on boards accused of fraud. Section 7 concludes.

We investigate reputational effects of financial fraud for outside directors of firms accused of fraud using a sample of firms facing class action lawsuits alleging violation of SEC rule 10(b)-5. Despite almost no evidence of abnormal turnover from the board of firms accused of fraud, we find that fraud is followed by a large and significant decline in the number of other board appointments held by outside directors. This decline is consistent with both a reputational penalty being borne by outside directors as well as an endogenous adjustment of monitoring expertise, where the expertise is reallocated to firms that are revealed to be more fraud-prone than previously expected. We show that a contagion effect exists for financial fraud through the board of directors. Firms that share directors with other boards accused of fraud are more likely to face fraud allegations themselves. When a firm faces a fraud class action lawsuit, other firms that employ outside directors of the defendant firm also experience a significant decline in valuation. Both these effects increase with the severity of the fraud allegation as measured by AAER releases and settlement amounts. The valuation loss for the interlocking firms is magnified if these firms possess weak governance characteristics and if the interlocked directors play a potentially critical role in influencing the likelihood of fraud due to their status as a member of the audit committee of either the sued or the interlocked firm, or as the CEO of the interlocked firm. Our findings show that outside directors are more likely to lose other board appointments when the severity of the fraud allegation is high, and when the outside director sits on the audit committee of the interlocked firm. Directorships are also more likely to be lost at firms with strong corporate governance, as measured by the Gompers, Ishii, and Metrick (2003) index. We also find that investors of interlocked firms experience positive announcement returns when a sued director departs the board. Overall, our results illustrate that fraud allegations have significant reputational consequences for outside directors of these firms and valuation effects for the other firms that are linked to sued firms through interlocked directorships.