Corporate Fraud, Governance, and Auditing

We analyze corporate fraud in a setting in which managers have superior informa-tion but are biased against liquidation because of their private benefits from empire building. This may induce them to misreport information and even bribe auditors when liquidation would be value-increasing. To curb fraud, shareholders optimally design corporate governance by jointly choosing audit quality and managerial com-pensation. We analyze how country-level rules affect these firm-level choices. Our analysis underscores that different country-level governance provisions have differ-ent effects on firm-level governance: Some act as substitutes of internal governance mechanisms, whereas others enhance their effectiveness and therefore complement them. (JEL G28, K22, M42) Private benefits of control often bias managers in favor of corporate expansion plans, even when these are unprofitable, and against liquid-ation or restructuring decisions, even when these would be desirable. But shareholders can design firm-level governance so as to mitigate this man-agerial bias toward empire building and against efficient liquidation. T