Board Composition and Corporate Fraud in Japan: The Role of Internal and External Directors

Abstract

The increasing incidence of corporate fraud worldwide has renewed interest in studying the relationship between governance structures and fraud occurrence. Previous studies have predominantly examined the effect of external directors on preventing fraud. However, the efficacy of internal directors in preventing fraud is crucial to understanding corporate fraud in the context of Japan. This is because (a) Japanese corporate boards are dominated by insiders, and (b) external directors may be ‘grey’ and are not fully independent. This study examines board composition and corporate fraud in Japan focusing on the attributes of internal directors to test whether board homogeneity affects fraud occurrence. We construct panel data consisting of about 9,000 firms listed on the Tokyo Stock Exchange between 2015 and 2020. Panel regression results show that longer tenure of internal directors is associated with higher fraud. More importantly, we find that higher share of lifetime directors is associated with higher fraud risk, and that neither external nor internal directors from parent firms are effective in preventing fraud in the Japanese context. Results advance our understanding of the intricate and context-specific relationship between board composition and corporate fraud. Our study makes a strong empirical addition to behavioural agency theory and homophily theory.

Authors: Asuka Takaoka, Hiroshi Ono

ICS Faculty: Hiroshi Ono

Published in: Organizational Science

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