How Diversity, Oversight And Healthy Boundaries Can Stop White-Collar Crime

To fight white-collar crime more aggressively, the Justice Department recently announced new enforcement measures, revealing incentives for companies to disclose any wrongdoing as soon as they learn about it.

Encouraging companies to disclose known corporate crimes and punishing them more severely when they don’t do so can be effective. A different approach – encouraging companies to put more women, outsiders and financial experts on their boards – might curb white-collar crime first.

Misconduct such as accounting fraud, insider trading, and kickback conspiracies can happen when executives face unrelenting pressure to perform (which is exacerbated by some incentive plans) or when executives believe they can rationalize their unethical actions—they believe everyone else can also do.

Corporate crime can also occur when directors are careless or have incomplete information, giving executives the opportunity to cut corners or misrepresent their activities. Theranos, the health-tech company whose CEO, Elizabeth Holmes, has claimed to have developed innovative and accurate blood-testing devices, may well be the prime example of lax board oversight. At least one Theranos director has testified that he has relied entirely on Holmes’ verbal claims about the company’s technology. (In January, a jury found Holmes guilty of defrauding investors and lying about the devices.)

How to prevent white-collar crime

Some board configurations appear to limit executives’ ability to commit corporate crimes. Here are a few board changes to consider to avoid misbehaving:

Add more women to corporate boards. When companies stack their boards with men, misconduct tends to increase; Adding women to their boards reduces misconduct, according to several recent studies, including one by a team of European researchers analyzing fines for misconduct by banks. One explanation for this could be the overconfidence of executives, an indicator of white-collar crime. Compared to women, men in influential corporate positions tend to be more cocky when measured by how much they overestimate their companies’ returns. This is exactly what a team of researchers from the National University of Singapore and Boston College has shown.

Management positions are stepping stones to board positions in companies. When men serve as directors, they can bring their hubris into the boardroom. Companies with more men on their boards may not be as vigilant in identifying risks. You can expect narrower ranges and lower probabilities of negative outcomes from questionable business strategies. Nor can they see all the implications of potential problems that they spot. With more female directors, boards can develop broader perspectives.

Companies that have more women on their boards statistically commit fewer white-collar crimes and less serious ones, possibly because women help calibrate board confidence and risk-taking. These are the conclusions of a study by researchers from York University, the Open University of Hong Kong and China Europe International Business School. They align with other published studies (including one of mine) showing how adding more women to boards of directors can accelerate product recalls and reduce claims of discrimination by companies.

Avoid conflicts of interest.

A board of directors is designed to oversee and advise the CEO on behalf of the company’s owners or shareholders. But directors who are closely associated with the company — such as chief executives — may have self-interested reasons not to challenge the CEO. For this reason, some regulators, including the New York Stock Exchange and Nasdaq, require large public companies to appoint a majority of independent directors who have “no material relationship” with the company.

Those requirements don’t necessarily apply to private firms, where barely a third of directors are independent, according to a study by Crunchbase and HimforHer. They also do not apply in all countries.

An independent audit committee is a better insurance against misconduct than the independence of the board as a whole. Along with colleagues from McMaster University, Georgia State University and Lehigh University, we came to this finding after reviewing and analyzing data from 135 separate studies on a variety of corporate crimes including financial fraud, insider trading, tax evasion, insurance fraud and price discrimination.

A fully independent audit committee is also more effective against fraud than having someone other than the CEO chair the board, a tactic that the Conference Board says is gaining acceptance. For companies listed on stock exchanges such as the NYSE and Nasdaq, the audit committee of the board of directors must be fully independent. Companies without such requirements would be well advised to ensure their audit committee is as independent as possible.

Make sure directors have the right expertise and avoid chumming with the CEO.

Boards are better equipped to uncover fraud when boards have financial expertise. When financially savvy directors are also materially detached from the firm and sit on board review boards, a study by the University of Alabama and HSBC found the boards to be particularly effective in curbing white-collar crime.

When directors are familiar with the companies they advise, executives have fewer opportunities to commit corporate crimes. In the Theranos case, the directors may not have had sufficient relevant knowledge to evaluate the CEO’s claims. It can be particularly difficult for independent directors to gain knowledge of the inner workings of a company. It can take years of service on a company’s board of directors. But spending many years on the same board carries a different risk: becoming too friendly with the CEO. When a board consists of friends of a CEO, its directors may not question as many management decisions or identify problems.

The addition of women to boards of directors, having only independent directors on the audit committee, and balancing directors’ knowledge of the company with an independent relationship with the CEO are important adjustments that have the potential to curb corporate crime.

If more companies make these adjustments to their boards, the Justice Department could find there are fewer companies to prosecute with the tougher measures announced.