Who Blows the Whistle on Corporate Fraud? Alexander Dyck, Adair Morse, and Luigi Zingales NBER Working Paper No. 12882 February 2007 JEL No. G3 Abstract What external control mechanisms are most effective in detecting corporate fraud? To address this question, we study all reported cases of corporate fraud in companies with more than $750 million in assets between 1996 and 2004. We find that fraud detection does not rely on one single mechanism, but on a wide range of actors. Only 6% of the frauds are revealed by the SEC and 14% by the auditors. More important monitors are media (14%), industry regulators (16%), and employees (19%). Before SOX, only 35% of the cases were discovered by actors with an explicit mandate. After SOX, the performance of mandated actors improved, but still account for only slightly more than 50% of the cases. We find that monetary incentives for detection in frauds against the government influence detection without increasing frivolous suits, suggesting gains from extending such incentives to corporate fraud more generally. The paper analyzes the mechanisms that contribute to fraud detection and their relative efficiency in terms of time it takes them to bring a fraud to light. It also examines the costs and benefits of whistle-blowing faced by market-based actors. The paper explores the changes in environment occurred after 2002 and their effects on the relative frequency of different whistleblowers. It summarizes the lesson we can draw from our analysis and concludes. The paper finds that no specific actor dominates the revelation of fraud. Even using the most comprehensive and generous interpretation, shortsellers and equity holders revealed the fraud in only 9 percent of the cases. Financial analysts and auditors do a little better (each accounting for 14 percent of the cases), but they hardly dominate the scene. The Securities and Exchange Commission (SEC) accounts for only 6 percent of detected frauds by external actors. More surprising is the key role played by actors who lack a direct role in investment markets, such as the media (14 percent), non-financial-market regulators (16 percent), and employees (19 percent). The paper also finds that the relative efficiency of those actors can be measured by the average speed with which these actors bring fraud to light. Financial analysts and short sellers are in a league of their own, taking only a median duration of 9.1 months to reveal fraud. These are the players whose market role is closest to a financial monitoring mechanism. Frauds that make it through these monitors are then caught by those with a significant stake in the firm: external equity holders (15.9 months), suppliers, clients and competitors (13.3 months). Non financial market regulators and auditors also seem to intervene at a similar speed (Who Blows the Whistle on Corporate Fraud? Alexander Dyck, Adair Morse, and Luigi Zingales NBER Working Paper No. 12882 February 2007 JEL No. G3 Abstract What external control mechanisms are most effective in detecting corporate fraud? To address this question, we study all reported cases of corporate fraud in companies with more than $750 million in assets between 1996 and 2004. We find that fraud detection does not rely on one single mechanism, but on a wide range of actors. Only 6% of the frauds are revealed by the SEC and 14% by the auditors. More important monitors are media (14%), industry regulators (16%), and employees (19%). Before SOX, only 35% of the cases were discovered by actors with an explicit mandate. After SOX, the performance of mandated actors improved, but still account for only slightly more than 50% of the cases. We find that monetary incentives for detection in frauds against the government influence detection without increasing frivolous suits, suggesting gains from extending such incentives to corporate fraud more generally. The paper analyzes the mechanisms that contribute to fraud detection and their relative efficiency in terms of time it takes them to bring a fraud to light. It also examines the costs and benefits of whistle-blowing faced by market-based actors. The paper explores the changes in environment occurred after 2002 and their effects on the relative frequency of different whistleblowers. It summarizes the lesson we can draw from our analysis and concludes. The paper finds that no specific actor dominates the revelation of fraud. Even using the most comprehensive and generous interpretation, shortsellers and equity holders revealed the fraud in only 9 percent of the cases. Financial analysts and auditors do a little better (each accounting for 14 percent of the cases), but they hardly dominate the scene. The Securities and Exchange Commission (SEC) accounts for only 6 percent of detected frauds by external actors. More surprising is the key role played by actors who lack a direct role in investment markets, such as the media (14 percent), non-financial-market regulators (16 percent), and employees (19 percent). The paper also finds that the relative efficiency of those actors can be measured by the average speed with which these actors bring fraud to light. Financial analysts and short sellers are in a league of their own, taking only a median duration of 9.1 months to reveal fraud. These are the players whose market role is closest to a financial monitoring mechanism. Frauds that make it through these monitors are then caught by those with a significant stake in the firm: external equity holders (15.9 months), suppliers, clients and competitors (13.3 months). Non financial market regulators and auditors also seem to intervene at a similar speed (