The Effects of Post-SOX Corporate Governance on Fraud Prevention and Detection: A Review of the Conceptual and Empirical Research

• In Event: Internal Control, Tone at the Top, Corporate Governance and Financial Reporting Quality

Abstract

In a response to the massive corporate fraud scandals occurred at large corporations, at the turn of the 21st Century, Congress reacted by passing the Sarbanes-Oxley (SOX) act of 2002. The goals of SOX were to restore the public’s trust in the financial markets and its confidence in the accounting and auditing profession, by strengthening the corporate governance system, and improving the quality of financial reporting. Since the enactment of SOX, there has been an on-going emphasis on the need to strengthen corporate governance, as a means to deter, detect, and prevent future egregious fraud. Prior empirical research examined the various effects of corporate governance mechanisms and their characteristics on fraud occurrence and detection. This body of research provides evidence that strong corporate governance is associated with higher quality financial reporting, in terms of fewer restatements, lower levels of earnings management, and a lower incidence of fraud. After a decade-long of governing under SOX provisions, it is imperative to ask whether SOX has fulfilled its promises to strengthen corporate governance mechanisms and to improve the quality of financial reports. In an effort to shed light on the overall effects of corporate governance on the financial reporting process under SOX, and to contribute to the corporate governance and fraud literature, this study complements and extends prior literature reviews (namely the review by Cohen et al. 2004). While the purpose of this paper is to provide a coherent review of the extant conceptual and empirical research, I specifically focus on post-SOX research conducted in 2003 and thereafter. To my knowledge, this is the first comprehensive literature review in the post-SOX era that takes a new holistic approach to corporate governance (similar to the pre-SOX review by Cohen et al., 2004). Another unique aspect of this current review is that it integrates public company’s top management and the internal controls structure into the analysis, and thus it recognizes the importance of their played roles in the corporate governance ‘mosaic’ and, consequently, in the financial reporting process. In the final section of this review, I conclude by identifying certain gaps in the corporate governance and fraud literature, which may still represent some avenues for future empirical research, in corporate governance and financial reporting.

Author

• Sam M Joseph, University of Ljubljana