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The finding that there exists a positive relation between the level of debt and corporate fraud is not unexpected. In China, although the state-owned banking system operates differently from truly commercial banks, application for loans is also subject to the checks and procedures and meets the set lending criteria. Borrowers would need to demonstrate a sound financial position and acceptable performance. Debt contracts would need to be signed and debt restrictions to be abided by, although often they are not strictly enforced. Like in the West, firms and their managers would have incentives to manipulate financial results to avoid violation of debt constraints, which explains why as the debt ratio increases, the likelihood of committing financial statement fraud by the firm increases.
There is no relation between BOD shareholding and corporate fraud, which differs from what is observed in the West. This is likely due to the fact that, in China, inside board directors and top management of listed firms typically hold negligibly low percentages of shares of their firms. In the sample firms of this study, 54 percent of the inside directors who hold shares in their firms hold less than 0.01% of the firm’s share issues and 91 per cent of the shareholding directors hold less than 0.1% of their firm’s share issues. Moreover, most of the directors’ shares (those obtained from IPO) are not tradable. As a result, there is little association between the market performance of firms’ shares and the personal wealth of firms’ directors through their shareholding in the firms. This perhaps explains why BOD shareholding is not related to the likelihood of corporate fraud among Chinese firms.
There is no relation between the proportion of BODs without remuneration from the firm, which is used as a surrogate for independence of BOD, and the likelihood of fraud. Similarly, the proportion of supervisors without remuneration from the firm, which is used as a surrogate for audit committee, has no effect on corporate fraud. However, there are noticeable differences between BODs without remuneration from the firm in China and independent BODs in the West and between supervisory board in China and audit committee in the West. Unlike in the West where independent BODs are often professional people with expertise in relevant areas, in China, non-remunerated directors are usually honorary appointments of distinguished personalities made by the controlling shareholder for public relations purposes to lend prestige to the firm or to provide political and commercial connections. To perform an oversight function over management is perhaps not their priority. Membership of supervisory board typically comprises retired government or company officials and employee representatives. Most of the supervisors appointed to the supervisory board are former senior staff (including top management) in the firm and have a long association with the firm. According to Lin (2001), there is no evidence of supervisory boards or non-executive BODs performing substantive oversight functions over the executive BODs and senior management. Instead, they are often “captured”: they become part of the group of insiders (the board chairman, CEO and other executive BODs who are normally appointed by the controlling shareholder, typically the state) and identify with their interests. Therefore, it is not surprising that non-remunerated BODs and supervisors do not exert a positive influence in reducing corporate fraud.
Whether the chair of BOD is also CEO or the two positions are separately held does not make a difference on the likelihood of fraud in Chinese firms. This result is consistent with Beasley’s (1996), but in contrast to Sharma’s (2004). Similarly, the level of the top management’s remuneration has no effect on corporate fraud, which is not consistent with the findings in the western context. The probable explanations lie in the unique features of China’s market with the predominance of state ownership, the lack of incentives in the remuneration system for management and the absence of a managerial market. As both the board chair and CEO are normally appointed by the government to represent its dominating state shareholding and their remuneration is unrelated to the firm’s performance, they would have little incentive to commit financial statement fraud. Whether the board chair and CEO roles are separate or not would not change this nature. Furthermore, the management remuneration and performance appraisal practices are also unique. Unlike in the West, the remuneration for top management in China is relatively low as compared to that in western countries and does not includes a bonus scheme. On the other hand, the money income is only part of total compensation. A significant proportion of total income accrues in non-monetary forms (e.g., housing, health care, etc.), which is not associated with performance (Lin, 2001). As a result, top management of Chinese firms is unlikely to engage themselves in the manipulation of financial results for the purpose of gaining financial compensation.
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