University of Southern California

How To Tackle Corporate Fraud
May 21, 2010

India's B. Ramalinga Raju, once widely recognized for exemplary corporate governance and hailed as a role model recently admitted to India's largest-ever corporate fraud—a staggering $1.47 billion.

This event is but one in a slew of global breakdowns in corporate governance, according to USC Marshall Professor Nandini Rajagopalan and colleague Yan Zhang. Such breakdowns in the US are driven by a weak regulatory system and distance between diffused shareholders and hired management. In China and India they are driven by state- and family-owned businesses that are often run by powerful insiders unfettered by serious oversight.

The problem is the same (fraud) but the cause is different; "while the United States…needs to deal with the challenges posed by a decentralized and porous regulatory system, developing countries lack a regulatory structure with the political will and judicial support to enforce reforms that are enacted."

Regardless of their origins, corporate governance breakdowns can be limited by employing the following remedies:

Make fraud cost-prohibitive, using strong monitoring mechanisms that catch corporate misdeeds, and strictly enforcing severe penalties. "The greater the probability that the fraud will be discovered," they note, "the less likely it is that a company or its management will commit a fraud."

Reduce its perceived benefits. "The prevalence of huge financial payouts for top executives and the low personal risk associated with performance failures have clearly increased the pecuniary benefits associated with deviant corporate behaviors." When potential fraudsters know the winner won't take all, their incentive will diminish.

The Bottom Line: Rajagopalan and Zhang conclude that "the most effective and sustainable governance reforms will be those that simultaneously increase the costs of corporate frauds and decrease the benefits that individuals and corporations can derive from ignoring governance norms and laws."

Nandini Rajagopalan (USC Marshall School of Business) with Yan Zhang (Rice University), "Recurring failures in corporate governance: A global disease?", Business Horizons (Executive Digest), 2009, 545-552.

Read the entire article here.