Corporate governance and likelihood of financial statement fraud: Evidence from Sri Lanka : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

This research investigates the relationship between Corporate Governance (CG) and the likelihood of financial statement fraud in Sri Lanka. This is achieved through an examination of the status of CG compliance and an examination of the effect of CG and the effect of gender diversity on the likelihood of financial statement fraud of listed companies in Sri Lanka. CG compliance status was examined using disclosures of both voluntary CG best practices and mandatory CG listing rules in annual reports. The extent of compliance is assessed using content analysis codebooks. Further, the effect of CG on the likelihood of financial statement fraud is examined focusing on selected practices: board effectiveness, audit committee characteristics, audit quality, and ownership structures. Board gender diversity and audit committee gender diversity are also examined. The research sample consists of 207 Sri Lankan listed companies on the Colombo Stock Exchange for the nine years, 2009 to 2017. Three phases were conducted: Phase I – content analysis, Phase II – CG index, and Phase III – financial statement fraud model. All CG data was gathered manually from annual reports or company websites using content analysis. Company financial information was retrieved from the Bloomberg database. The research used the Beneish M-score model to identify the likelihood of financial statement fraud and analysed the data using a traditional logistic regression method. System generalised method of moment estimators were employed to resolve issues associated with endogeneity and reverse causality. Despite an upward trend of CG compliance, the research found that CG compliance varies greatly between companies. While most Sri Lankan companies have good levels of compliance with CG practices for the board of directors, and the audit and remuneration committees, moderate levels of compliance exist for other CG disclosures. The lowest level of compliance was associated with the nomination committee. Overall, the research found that Sri Lankan listed companies comply with the minimum CG disclosure requirements, but not with the comprehensive set of voluntary and mandatory CG practices. The research found that fraudulent firms have lower board effectiveness, less effective audit committee structures, lower audit quality, and higher ownership concentration. The likelihood of financial statement fraud risk increases when a weak CG structure exists in a firm. The research also shows that while audit committee gender diversity has a significant negative effect on the likelihood of financial statement fraud, board gender diversity has a negative but insignificant effect. The research found that female representation in the audit committee strengthens its oversight role and improves firm performance. In short, gender-diverse audit committees reduce financial statement fraud and improve firm performance. This research has several implications for CG, financial statement fraud, and firm performance. The results indicate the need both for proper CG enforcement and monitoring mechanisms for Sri Lankan listed companies and increased training for directors. Both financial and non-financial information affect the likelihood of financial statement fraud and thus play a vital role in stakeholders’ decision-making. Legislators and companies’ board of directors should consider female directors’ contribution to higher managerial positions as increased participation in audit committees have been shown to enhance firm performance. Ultimately, this research provides greater insight into CG disclosure practices and presents a comprehensive examination of financial statement fraud and gender diversity.