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Discussion Paper Details

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Title: Corporate Fraud, Governance and Auditing

Author(s): Giovanni Immordino and Marco Pagano

Publication Date: December 2008

Keyword(s): accounting fraud, auditing, corporate governance, managerial compensation and regulation

Programme Area(s): Financial Economics

Abstract: We analyze corporate fraud in a model in which managers have superior information but are biased against liquidation, because of their private benefits from empire building. This may induce them to misreport information and even bribe auditors when liquidation would be value-increasing. To curb fraud, shareholders optimally choose auditing quality and the performance sensitivity of managerial pay, taking external corporate governance and auditing regulation into account. For given managerial pay, it is optimal to rely on auditing when external governance is in an intermediate range. When both auditing and incentive pay are used, worse external governance must be balanced by heavier reliance on both of those incentive mechanisms. In designing managerial pay, equity can improve managerial incentives while stock options worsen them.

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Bibliographic Reference

Immordino, G and Pagano, M. 2008. 'Corporate Fraud, Governance and Auditing'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7104