Corporate fraud and independent director's re‐appointment: Information hypothesis or favouritism hypothesis?

Abstract

Using the analytical framework of social identity theory, this paper explores how a special corporate governance arrangement in the Chinese capital market, i.e., independent directors' re‐appointment, affects corporate ethical behaviours. Using the bivariate probit model, we find that independent directors’ re‐appointment significantly increases corporate fraud propensity, indicating that the favouritism towards re‐appointed independent directors by firms generated from social identity plays a dominant role in the corporate governance outcome in a relationship‐based society. Our results remain consistent after using an exogenous shock to alleviate the endogenous problems. The policy implication of this paper is that the corporate arrangement of re‐appointed independent directors in the Chinese capital market may impair stakeholders’ benefit and weaken business ethics. Top‐level institutional design should be improved and consider thoroughly the effects of social identity on corporate governance outcomes.