Risk & Compliance

More Board Independence, Less Fraud?

A new study finds that ''a higher proportion of independent outside directors is associated with less likelihood of corporate wrongdoing.''
Stephen TaubJune 29, 2004

The more independent directors on a company’s board, the less likely it is to be accused of fraud, according to a study published in the June issue of Financial Analysts Journal, a publication of the CFA Institute.

Three professors — Hatice Uzun of Long Island University, Samuel Szewczyk of Drexel University, and Raj Varma of the University of Delaware, Newark — examined 133 companies accused of fraud between 1978 and 2001. The researchers matched them with 133 companies — of similar size and in the same industries — that had not been accused of fraud, then compared the two groups for statistically significant differences in board member independence, board size, frequency of board meetings, and other variables.

Compared with the control group, companies that had been accused of fraud had a lower percentage of independent directors (that is, board members with no business or personal ties to the company) and lower percentage of outside (that is, non-executive) directors.

The boards of companies accused of fraud were also less likely to have an audit committee. In addition, their audit, compensation, and nominating committees also had a lower percentage of independent directors.

The study did find that companies with a compensation committee were actually more likely to be accused of fraud. However, the authors were quick to point out that the fewer business or personal ties that compensation committee members had with the company and its executives, the less likelihood there was of an accusation of fraud.

“We found that a higher proportion of independent outside directors is associated with less likelihood of corporate wrongdoing,” wrote the authors. Acknowledging that the Sarbanes-Oxley Act requires public companies to create independent audit committees, the authors added that “Our findings support this requirement and the recent tightening of the definition of ‘independent’ by NYSE and Nasdaq.”

The authors did note that they did not find statistically significant differences between the two groups of companies when it came to a number of other governance criteria, many of which became critical issues at this year’s annual meetings.

Those criteria include board size; frequency of board meetings; frequency of meetings for the audit, compensation, and nominating committees; whether a board has a nominating committee; financial performance of the company; the length of time that the CEO has served on the board, and whether the president or CEO also served as chairman of the board.

“These results suggest that the influence of the CEO on the board does not detract from its effectiveness in monitoring for fraud,” wrote the authors.