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Corporate fraud and external social connectedness of independent directors

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  • Kuang, Yu Flora
  • Lee, Gladys

Abstract

We examine the effects of independent directors' external social connectedness on corporate fraud commission and detection. The results show that well-connected independent directors do not affect the likelihood of fraud commission but significantly reduce the likelihood of fraud detection given occurrence of a fraud. In particular, with a one-standard-deviation increase in independent directors' connectedness, the likelihood of fraud detection reduces by 22.5%. We also find that the consequences of fraud commission faced by firms with well-connected independent directors are less severe as fraud remains undetected for a longer period of time and fewer people are charged with fraud when independent directors are well connected. We further show that independent directors' connections to fraud firms significantly increase a firm's propensity to fraud commission and the likelihood of fraud detection is also higher. Overall, our results suggest that directors' personal networks have a “dark side”. Regulators should be aware of unintended consequences associated with directors' external social connections when considering how to prevent and detect corporate fraud.

Suggested Citation

  • Kuang, Yu Flora & Lee, Gladys, 2017. "Corporate fraud and external social connectedness of independent directors," Journal of Corporate Finance, Elsevier, vol. 45(C), pages 401-427.
  • Handle: RePEc:eee:corfin:v:45:y:2017:i:c:p:401-427
    DOI: 10.1016/j.jcorpfin.2017.05.014
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    More about this item

    Keywords

    Corporate governance; Fraud commission; Fraud detection; Social connectedness;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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