Abstract
A wave of financial irregularity broke out in the United States in 2001-2002,
culminating in the Sarbanes-Oxley Act of 2002. A worldwide stock market bubble burst
over this same period, with the actual market decline on a percentage basis being
somewhat more severe in Europe. Yet, no corresponding wave of financial scandals
involving a similar level of companies broke out in Europe. Indeed, those scandals that
did arise in Europe often had American roots (e.g., Vivendi, Ahold, Adecco, etc.). Given
the higher level of public and private enforcement in the United States for securities fraud,
this contrast seems perplexing.
What explains this contrast? This paper submits that different kinds of scandals
characterize different systems of corporate governance. In particular, dispersed
ownership systems of governance are prone to the forms of earnings management that
erupted in the United States, but concentrated ownership systems are much less
vulnerable. Instead, the characteristic scandal in concentrated ownership economics is the
appropriation of private benefits of control. Here, Parmalat is the representative scandal,
just as Enron and WorldCom are the iconic examples of fraud in dispersed ownership
regimes.
Is this difference meaningful? This article suggests that this difference in the
likely source of, and motive for, financial misconduct has implications both for the utility
of gatekeepers as reputational intermediaries and for design of legal controls to protect
public shareholders. What works in one system will likely not work (at least as well) in
the other. The difficulty in achieving auditor independence in a corporation with a
controlling shareholder may also imply that minority shareholders in concentrated
ownership economies should directly select their own gatekeepers.