Directors’ Joint Work on Corporate Fraud? The roles of Director Subgroup Interlocking Networks in China

Abstract

Although prior research has explored the influence of board’s external connectedness on corporate fraud in the U.S., how such influence works in economies with concentrate ownership like China remain largely unexplored. The highly concentrated ownership in China not only exacerbates principal-principal conflicts but also lead to the formation of director subgroup within the board and the separation of board’s external social networks. To explore the impact of board’s social network on corporate fraud in such a unique context in China, it is important to adopt a subgroup-level network lens. Filling this gap, using a binary probit regression model with partial observability on 1,530 Chinese publicly listed companies with corporate violation announcements data from 2003 to 2013, this study analyzes the impact of two director subgroup interlocking networks on corporate fraud occurrence and fraud detection. The empirical results show that high centrality in the dependent director subgroup interlocking network contributes to fraud deterrence, and the high centrality in the independent director subgroup interlocking network facilitates both fraud deterrence and fraud detection. This study contributes to corporate governance research by exploring the influence of social networks on corporate fraud with a subgroup-level network lens in China. Meanwhile, the formulation of two parallel director subgroup interlocking networks introduces a novel analytical framework for future interlocking directorship research in scenarios where the board is subject to a structured division.