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White-collar crime can cost a company from I percent to 6 percent of annual sales, yet little is known about the organizational conditions that can reduce this cost. Previous governance research has examined the link between block holders, boards of directors, or CEO compensation and fraud. In this study, these traditional measures of governance are found to have little impact. Instead, operational governance, including clarity of policies and procedures, formal crosscompany communication, and performance-based pay for the board and for more employees, significantly reduces the likelihood of a crime commission. Copyright © 2003 John Wiley & Sons, Ltd.
Key words: fraud; crime; governance; internal control
INTRODUCTION
The economic impact of fraud is immense. Estimates of the cost of white-collar crime to companies in the United States range from $200 billion (Touby, 1994) to $600 billion per year (Association of Certified Fraud Examiners (ACFE), 2002). This is massively greater than street crime losses of $3-4 billion (Baucus and Baucus, 1997) and total economic loss to victims of personal and property crimes of $15.6 billion (Bureau of Justice Statistics, 1999). Fraud can significantly impact the financial performance of a firm as it can cost a typical company between 1 percent and 6 percent of annual sales (Hogsett and Radig, 1994; Touby, 1994; ACFE, 2002). White-collar crime alone causes 30 percent of new business failures (Agro, 1978), without regard to the quality of the firms' strategy or assets.
Fraud has brought down many apparently wellperforming firms. Enron, Sunbeam, Cendant, and Waste Management are some of the most recent and spectacular examples. Even before Enron's collapse, the U.S. Securities and Exchange Commission was investigating more companies than ever for possible accounting fraud (Roland, 2001). The ability to prevent fraud, or value loss through fraud, has become a potential source of competitive advantage and improved financial performance for firms in today's economy.
This paper investigates whether firms' governance systems influence the probability of whitecollar crime. Governance systems comprise not only the board of directors and the CEO, but also operational systems within the firm through which management can influence the firm. Components of these systems have been examined with respect to their role in strategy process1 (Marginson, 2002), but not with regard to their impact on crime.
The...