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China’s enterprise reform adopts a unique approach through corporatisation (instead of privatisation) of the former state-owned enterprises. This approach together with the political and economic systems, social ethos and theoretical ideas (labelled “Chinese characteristics”), have resulted in a corporate governance system with unique features. They include the state dominance in ownership and control of listed firms (in the forms of state shares and legal person shares), government-appointed board directors and supervisory board members, among others. This study identifies eight governance variables and investigates their relations to the likelihood of corporate fraud. Using logit regression on a matched sample of 39 fraud and 39 no-fraud firms listed on China’s Stock Exchanges, this study finds that both state and legal person shares are negatively significantly correlated with fraud. However, it is argued that the underlying incentives for state shares to exhibit this effect differ from those for legal person shares. It is also found when debt ratio increases the likelihood of fraud increases. The other variables investigated do not show any significant effect; but a further analysis reveals these results are likely driven by factors such as the state dominance in ownership and the restrictions placed on the firms by government. 3795
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Keywords: corporate fraud; corporate governance;SOE reform,;state-owned shares; legal person shares; board of directors
1. Introduction
In recent years, the governance of the publicly listed companies has caught the attention of many relevant parties, such as, government regulators, business practitioners, investors, as well as academic researchers in both the developed and the developing worlds. The corporate governance issue has become a more alarming concern especially after the breakout of corporate scandals and the sudden collapse of some of the world largest companies1 as a consequence of the fraudulent action of corporate management. Corporate fraud and the resultant corporate collapse inevitably have a devastating and lasting effect not only on the immediate corporate stakeholders, but also on the society at large. In a study it was reported that the annual loss in the United States amounted to US$41.78 billions largely due to the various types of corporate fraud (Comer, 1985). The calamities of corporate fraud cost the Australian society in excess of A$20 billions per annum and are on the rise (Maslen, 1997).
In the developing world, the situations are equally, if not more, devastating. In China, for instance, it is widely believed that false accounting and financial misreporting are pervasive (Tam, 2000). In an assessment made in 1998, the China National Audit Office (CNAO) states that “cooked books”, embezzlement, fraud and “irregularities” in financial management are widespread among Chinese firms (CNAO, 1998; quoted in Lin, 2001).2 Lin (2001) observes, in a review of the annual reports of companies listed on the Shanghai Stock Exchange, that about 10 percent of listed companies have been or are involved in major litigations involving over ¥750 million, most of which are concerned with the negligence, improper behaviour and deliberate fraud on the part of senior management.
In the West, there have been studies that examine the relation between corporate governance and corporate fraud,3 aiming to reveal that certain governance mechanisms could be more effective than others in preventing the fraudulent behaviour of management. While both the external monitoring mechanisms (e.g., the debt and equity market, the market for corporate control and managers, and government regulations) and internal monitoring mechanisms (e.g., the composition of the board of directors, corporate ownership, and committee structure) play important roles in corporate governance, studies at the corporate level have generally focused on the internal mechanisms (e.g., Beasley, 1996; Abbott et al., 2000; Sharma, 2004). These studies find that certain internal mechanisms and structures are more effective than others in preventing and reducing corporate fraud (see, for example, Beasley, 1996; Abbott et al., 2000; Seamer and Psaros, 2000; Sharma, 2004).
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