New York (June 30, 2004) -- A recent study provides ammunition for current demands for more independence on the part of corporate boards, showing a correlation between a higher proportion of independent, outside directors and a lower likelihood of corporate fraud.
The study compared 133 companies that were accused of fraud between 1978 and 2001, and 133 companies of similar size and from the same industries that were not, searching for significant differences in director independence, board size and other variables. The result showed that the boards of the companies that were accused of fraud had fewer non-executive directors and fewer independent directors, and lower levels of independence on their audit, compensation and nominating committees.
Pointing to the new New York Stock Exchange and Nasdaq rules that require a majority of independent directors, the study’s authors -- three professors from Long Island University, Drexel University and the University of Delaware at Newark -- said, “Our results support this requirement and its underlying motivation. We found that a higher proportion of independent outside directors is associated with less likelihood of corporate wrongdoing.”
One surprising discovery was that companies accused of fraud were actually more likely to have compensation committees, suggesting that “compensation committees have been ineffective in evaluating and properly rewarding the performance of top executives,” the authors wrote. “They may also have designed compensation packages with dysfunctional incentives.”
The authors noted, however, that even within that unexpected correlation, their main discovery held true: As the proportion of independent directors on a compensation committee rose, the chance of the company’s being accused of fraud decreased.
The study was published in the June issue of the Financial Analysts Journal, a publication of the CFA Institute.
-- WebCPA staff
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