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Preventing and Detecting Accounting

Irregularities: The Role of Corporate Governance

Article in SSRN Electronic Journal January 2009

DOI: 10.2139/ssrn.1324143

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 PREVENTING AND DETECTING ACCOUNTING IRREGULARITIES:
THE ROLE OF CORPORATE GOVERNANCE

Nadia Smaili
University of Quebec in Montreal Business School

Ral Labelle
Chair in governance and forensic accounting
HEC Montral

January, 2009

Acknowledgments

This paper is based on the dissertation of Nadia Smaili. We are especially grateful to the dissertation committee
members Bernard Sinclair-Desgagn and Michel Magnan for their support and guidance. We appreciate the valuable
comments received from Luo He, Zoe-Vonna Palmrose, Stphane Rousseau, Jean-Marc Suret and Daniel B.
Thornton as well as those from participants in the 2007 EAA Annual Meeting, the 2006 CAAA Ph. D. Workshop,
and workshops at UQAM, University Laval, and Ivey Business School. The authors also gratefully acknowledge the
financial support from the Society and Culture Research Fund of Quebec (FQRSC) and the Social Sciences and
Humanities Research Council of Canada (SSHRC). The usual caveat applies.

Electronic copy available at: http://ssrn.com/abstract=1324143

 PREVENTING AND DETECTING ACCOUNTING IRREGULARITIES:
THE ROLE OF CORPORATE GOVERNANCE

ABSTRACT

This study examines the extent to which corporate governance acts as an efficient means of
protecting investors against accounting irregularities, thus contributing to the literatures on governance, on
fraudulent financial statements and on the public enforcement of securities laws by market authorities. It
does so by empirically testing the prediction that the seriousness or level of non compliance of
irregularities detected by market authorities is negatively associated with the quality of governance. For
that purpose, a sample of 107 firms identified as reporting issuers in default by the Canadian Securities
Administrators and the Ontario Securities Commission is matched with 107 other control firms based on
industry, size, stock exchange membership and date of default.

Consistent with prior research, we first find that the occurrence of accounting irregularities is
negatively associated with the quality of corporate governance. Specifically, results of univariate analyses
indicate that issuers in default have less effective boards, audit committees, and auditors as benchmarked
against best practices than the matched control group. Our main contribution resides in our multivariate
test of the relation between corporate governance as a system and the gravity of accounting irregularities.
The level of non compliance of accounting irregularities is indeed higher when firms: (1) have fewer
independent directors on their boards and audit committees and no block holder, (2) have recently
changed auditors, (3) have a CEO who is also the Chairperson, and (4) show poor communication
between their audit committee and their auditor, while having large financing requirements.

Keywords: Governance, accounting irregularity, financial fraud, restatement, Ontario Securities

Commission, regulation, issuer in default.

JEL Classification: G38, G34, G32.

Electronic copy available at: http://ssrn.com/abstract=1324143

1. Introduction and overview of results

Corporate governance (CG) has been attracting increasing attention over the last fifteen years,
owing in part to financial scandals, such as Worldcom, Parmalat and Hollinger, in the US, Europe and
Canada. Academic research has further brought to light that unethical financial reporting practices, such as
restatements and fraudulent financial statements, are often associated with some poor CG practices (He et
al., 2007; Cohen et al., 2004; Nieschwietz et al., 2000). However, most studies do not consider the
interactions among CG mechanisms. Furthermore, they generally examine only one type of accounting
irregularity (AI) at a time. They do not take into account their relative gravity and whether the AI was
unveiled by management, the board, the auditor, or the regulator. This study addresses these shortcomings.

First, as suggested by Cohen et al. (2004), Bushman and Smith (2001: 286), and Molz (1995),
rather than only examining individual board (Beasley, 1996), audit committee (Abbott et al., 2000 and
2004) or auditor (Carcello and Nagy, 2004) characteristics, the study also considers governance as a
system by combining these characteristics into scores and interaction terms in the empirical model. So, in
a first step, as in prior research, partial models are used to determine whether individual CG mechanisms
are negatively related to the level of non compliance of accounting irregularities. In a second step, full or
integrative models are used to study the effect of governance as a system.

Second, in their literature survey, Stolowy and Breton (2004) underline the absence of consensus
around the definition of accounting irregularities. Dechow and Skinner (2000) also suggest distinguishing
earnings management within GAAP from fraudulent manipulations. The fact that AI are often defined
differently from one study to the other may create confusion and lead to difficulties in comparing and
interpreting results.

Furthermore, studies do not always distinguish between whether the irregularity is detected by
management, the board, the auditor or the regulator. For instance, Agrawal and Chadha (2005) examine
restatements initiated by the auditor or the SEC; Abbott et al. (2004), those initiated by the board of
directors, the auditor or the SEC and McMullen (1996) restatements initiated by the board or the auditor.
When an AI is detected by the board or the auditor, it usually translates good governance while, when it is
detected by the regulator, it indicates that the firms CG system failed to prevent the AI. To examine the
quality of CG, this study focuses on the accounting irregularities detected by the regulator, by comparing
the governance of firms in default of filing requirements to firms of a control group which are not in
default.

3
 While some studies examine the relation between governance and restatements (Palmrose and
Scholz, 2004; Abbott et al., 2004; Baber et al., 2005) and others between governance and fraudulent
financial statements (Beasley et al., 1996, Farber, 2005, Abbott et al., 2000), this study goes a step further
by examining if fraudulent firms, which is the most severe case of accounting irregularity, have worst
governance than restatement firms. In other words, it takes into consideration that accounting irregularities
are part of a continuum between low levels of non compliance with regulations and outright fraud and that
the governance of fraudulent firms may be worse than for firms that are able to correct an AI by restating
their financial statements.

Finally, little is known on the public enforcement of securities laws by market authorities outside
the US partly because, until recently, there was a lack of public data such as the information published by
the General Accountant Office and the SEC in the US. Furthermore, it has become more difficult to
conduct research on the presumed relation between governance quality and financial reporting quality in
the US as governance practices are more strictly regulated since the adoption of SOX. European countries
and Canada have adopted a principle based approach with regard to governance practices. Therefore, we
have chosen to conduct this research in Canada as the comply or explain approach adopted in this
institutional setting leaves more latitude to management in their choice of governance policy and allows
for the variability needed to conduct statistical analyses.

The objective of this paper is to contribute to the literatures on governance, fraudulent financial
statements and public enforcement of securities laws (La Porta et al., 2006: 4 & 12; Palmrose, 1999;
Bonner and Palmrose, 1998). We wish to further these lines of research by studying the role various levels
of governance quality may play in preventing accounting irregularities detected by market authorities and
in minimizing their gravity. We first examine the governance characteristics of the firms that were
identified as having committed accounting irregularities. We then examine whether there is a negative
relation between the quality of CG and the gravity of AI. Those accounting irregularities are the ones
committed by firms identified as reporting issuers in default (RID) on a shame list maintained by the
Canadian Securities Administrator and the Ontario Securities Commission (OSC).

To our knowledge, this is the first time these regulatory data are used in academic research aimed
at linking poor governance and financial misreporting practices. Since the identification of RID is
important for investors protection, the ultimate objective is to help policy makers and national securities
administrators improve their investigative effectiveness through a better understanding of the CG

4
characteristics of those reporting issuers identified as being in default of financial statement filing
requirements.

Using the OSC list of RID for the period running from 2001 to 2005, we identify three levels of
non compliance by RID firms according to the level of sanction imposed by the OSC. The first one
includes 43 firms. These were removed from the RID list but put on a Re-filing and errors list after
making the corrections required by the OSC. To be put on that second list constitutes the lowest level of
sanction imposed by the OSC. The second level of non compliance includes 64 RID firms which were
issued a full cease trade order (CTO) or a CTO limited to management and insiders (M&I-CTO). The
third level consists of 11 RID firms which, on top of being issued a CTO, were cited for fraudulent
financial statements, the most severe level of sanction. This sample of 107 RID was matched with 107 non
RID firms on the basis of size, industry, stock exchange listing and date of default or sanction.

With regard to our empirical examination of the governance characteristics of firms committing
accounting irregularities, our results show several significant differences between RID and Non-RID
firms. For instance, issuers in default have, on average, fewer independent and financial expert directors
on their boards and audit committees than do the matching firms. Indeed, univariate statistical analyses
indicate that issuers in default have less efficient boards, auditors, and audit committees as per standard
benchmark measures of CG quality. We find that 65% of the issuers in default have a CEO who is also the
chair of the board, as compared to 20% for the matching control firms. Furthermore, the percentage of
financial experts on the audit committees of issuers in default is only 0.13%, as compared to 0.16% in
matching firms. Issuers in default tend to have larger financing needs and to change auditor in the year
before the default was detected. With regard to our multivariate analyses of the assumed negative
relationship between the CG system and the gravity of accounting irregularities, we find evidence that the
level of non-compliance among RID firms varies with the quality of governance.

The paper is organized as follows. In the next section, we present the institutional setting of our
study. In the third section, we review relevant theoretical and empirical literatures and discuss the assumed
negative relationship between CG and the seriousness of accounting irregularities. In the fourth section,
we present the research design. The empirical analysis and interpretation of the results are given in the
fifth section. In the last section, we conclude with a summary as well as some caveats and suggestions for
future research.

5
2. Institutional setting

In the past, most of the research on whether governance matters in the prevention and detection of
accounting irregularities was conducted in the US. Despite the lasting importance of this question, that
line of research has become difficult to conduct in the US. Indeed, the adoption of SOX has had for effect
to standardize governance practices and remove the variance needed to study the question. Furthermore,
little is known on the public enforcement of securities laws by market authorities outside the US largely
because, until recently, there was a lack of public data such as the information published by the General
Accountant Office and the SEC on AI and enforcement actions. In contrast to this rule-based approach,
Canada, as most countries in Europe and Asia1, has adopted a principle-based approach with regard to
governance practices. This institutional setting leaves more latitude to management in their choice of
governance policy and allows for the variability needed to conduct statistical analyses.

In Canada, an issuer must comply with the financial statement filing requirements (FSFR) of the
securities law of each provincial or territorial jurisdiction. Given the importance of the Toronto Stock
Exchange (TSX) relative to other securities markets in Canada, this paper focuses on the Ontario
Securities Commission (OSC) requirements. FSFR refers to all annual or interim OSC filing requirements
relative to financial statements or documents such as the Management Discussion and Analysis. OSC
policy 51-601 describes the key deficiencies with regard to FSFR which are summarized in Appendix 1.
This research focuses on accounting irregularities which are defined as default H in Appendix 1. This
FSFR concerns deficient financial statements disclosures or the acknowledgement by an issuer that
auditors report may no longer be relied upon. Pursuant to subsection 72(9) of the Ontario Securities Act,
since 2001, failure to comply with the OSCs FSFR may result in being placed on the list of reporting
issuers in default (RID) as shown in the left hand-side of Figure 1. The OSC policy also indicates how
the Commission determines whether a reporting issuer is in default of any requirement and the related
sanctions.

As shown in Figure 1, when a deficiency is detected by the OSC, the defaulting firm is put on the
Reporting issuer in default list and the Commission requires that the default be corrected. If the
correction satisfies the Commission, the issuer has to re-file, and his name is put on another list referred
to as the Re-filing and errors list2 for a period of three years [OSC staff notice 51-711 (amended May

1. See European Corporate Governance Institute - Index of all codes (http://www.ecgi.org/codes/all_codes.php).

2. The Re-filing and errors list identifies reporting issuers that were required as a result of a regulatory review to
(a) restate and refile financial statements; (b) implement accounting or disclosure changes on a retroactive basis, (c)
where the changes represent the correction of an error in the information as originally filed; (d) amend and refile
other continuous disclosure documents; or (e) file documents to correct a non-filing at an earlier date.

6
 2005)]. In more serious cases where the deficiency cannot be corrected or where the firms proposed
restatement does not satisfy the Commissions requirements, the OSC keeps the issuer under
investigation as he is suspected of fraud. The OSC may then either impose a Management and Insider
Cease Trade Order (M&I CTO) or a full Cease Trade Order (CTO) under paragraph 2 of subsection
127(1) of the Ontario Securities Act. The two types of cease trade orders may be imposed permanently or
for such period as is specified in the order. Finally, in the most serious cases of defaults such as the
production of fraudulent financial statements, management is indicted for fraud and the firm is subject to
enforcement actions.

So, as shown on the right-hand side of Figure 1, accounting irregularities committed by RID firms
may give rise to three levels of disciplinary actions: (1) a restatement, (2) a M&I-CTO or a full CTO and
(3) an enforcement action. An accounting irregularity which leads to a restatement is less serious than an
AI which leads to a CTO. In turn, an AI which only leads to a CTO is less severe than an AI or a fraud in
the financial statements, which also leads to an enforcement action.

In our research design, we use the above OSC tracking and enforcement system of reporting
issuers in default to identify a variety of financial statement defaults, along with their gravity and the
corresponding OSC disciplinary sanctions to measure the seriousness or level of non compliance of
accounting irregularities.

[Insert Figure 1 here]

3. Conceptual framework and hypotheses

In this section, we first position our studys intended contribution to the literatures on governance,
on fraudulent financial statements and on public enforcement of securities laws through the investigative
powers of market authorities (La Porta et al., 2006: 4 & 12; Palmrose, 1999). Then, following the
conceptual framework outlined in Figure 2, we examine in turn the monitoring effectiveness of the board
of directors, of the audit committee, and of the external auditor with regard to accounting irregularities
likely to call for various levels of sanctions by the OSC. We draw our arguments explaining why one
expects relations to exist between these observable monitoring variables and financial reporting quality
from agency theory and previous empirical studies.

Prior research on the relation between CG and financial reporting quality has focused either on
earnings management, which may be done within GAAP, or on accounting irregularities such as

7
fraudulent financial statements, which clearly overstep both GAAP and legal bounds. In most of the
studies, these unethical financial reporting practices and their consequences were studied one at a time and
in relation to limited CG practices. They therefore failed to fully consider that governance practices
interact and are part of a mosaic (Cohen et al., 2004) and that earnings management occurs on a
continuum, which may lead to fraud and value destruction (Jensen 2005).

For instance, McMullen (1996) is the only study to examine several consequences of financial
statement unreliability. She examines if the presence of an audit committee is associated with one of 5
potential consequences: shareholder litigation, management fraud, SEC actions, illegal acts and auditor
turnover. However, she examines those consequences separately and only in relation to the presence or not
of an audit committee. She admits (p. 101) several variables such as the audit committees composition,
independence and experience are omitted which can affect the association with financial statement
reliability. Klein (2002) focused on the relationship between earnings management and the characteristics
of audit committees and boards of directors, while Beasleys (1996) empirical analysis focused on the
relation between the board of directors composition and fraudulent financial statements. By the
simultaneous study of a range of accounting irregularities and CG practices as well as their interactions,
we hope to enhance the internal and external validity of the results.

The conceptual framework proposed in Figure 2 presents the hypothesized relationship and its
direction between various CG mechanisms and the gravity or level of non compliance (LNC) of the
accounting irregularities as defined in the previous section. It is based mainly on agency theory (Jensen
and Meckling, 1976). Under this contractual vision of organizations, managers are appointed by
shareholders to manage the firm in shareholders best interests. In this setting, the separation of ownership
and control over decision making creates a potential governance problem or a situation of information
asymmetry in favour of managers, who do not entirely assume the economic consequences of their
decisions. This situation can give rise to an ex ante adverse selection problem, if managers take advantage
of their position to manipulate information by committing accounting irregularities or even fraud, and to
an ex post moral hazard problem, if managers use it to shirk or undertake projects other than those
specified in the contract.

To reduce this asymmetry and the ensuing potential opportunistic behaviour, managers select the
level of agency costs they accept to bear to attain their governance quality target. This includes agreeing to
work under the authority of a more or less efficient board of directors or under the monitoring of a more or
less efficient audit committee or governance system (right-hand side of Figure 2) in order to reassure

8
shareholders that they are acting in shareholders interests. These mostly internal mechanisms complement
external market mechanisms such as institutional and other outside block ownership presented in the left
portion of Figure 2. Figure 2 also includes control variables for firms financing requirements, size and
current indebtedness. For instance, managers have an interest in being forthcoming in order to maintain
their firms credit rating in the financial market and their reputation in the labour market.

[Insert Figure 2 here]

3.1 Board and audit committee monitoring effectiveness

The board of directors and its audit committee play a crucial role in corporate governance,
especially in monitoring top management. Fama and Jensen (1983) see the board as a companys highest-
level control mechanism with ultimate responsibility over the way the firm is run. The literature on
restatement, fraudulent financial statements and the quality of financial reporting in general indicates that
the composition and characteristics of the board do influence its effectiveness. The main proxies used for
the boards power, competence and independence are the following variables: (1) proportion of
independent directors on the board (Farber, 2005; Baber et al., 2005; Uzun et al., 2004; Felo et al., 2003 ;
Anderson et al., 2003; Klein, 2002; Beasley, 1996 ; Dechow et al., 1996) or on its audit committee
(Abbott et al., 2000; Abbott et al., 2004; Bdard et al., 2004; Klein, 2002); (2) the presence of financial
experts (Farber 2005); (3) the number of seats directors hold on other boards (Beasley, 1996); and (4) the
separation of the positions of CEO and chairperson of the board, a measure of independence of the board
from CEO dominance (Abbott et al., 2000; Carcello et Nagy, 2004; Dechow et al., 1996; Farber, 2005).

Using a matching control firm design, studies by Beasley (1996), Abbott et al. (2004) and Baber et
al. (2005) indicate that the deterring effect of board independence on restatements may not be the same as
for fraudulent financial statements. Specifically, Beasley (1996) shows that the percentage of independent
directors is negatively associated with fraudulent financial statements. In contrast, Abbott et al. (2004) and
Baber et al. (2005) show that the relation between board independence and the probability of restatement
is not significant. Given these mixed results, our conceptual framework predicts that the percentage of
independent directors3 in fraudulent firms is likely to be lower than in CTO and restatement firms (Figure
2: H1). Similarly, it is expected that the presence of a non affiliated block holder on the board, as in
Abbott et al. (2004), will be negatively associated with the LNC of accounting irregularities.

3. Defined as a director unrelated to management as in the Dey (1994) and Saucier (2001) reports.

9
 Like Farber (2005), we also conjecture that the presence of financial experts on the board of
directors and on the audit committee prevents accounting irregularities and minimizes their gravity. To
better reflect the particularities of Canadian regulations, we use two variables to distinguish financial
expert directors from financially literate ones as defined in OSC regulations. The BoardExpert variable
represents the number of directors with a professional designation in accounting or finance (CA, CMA,
CGA or CFA) or with a specialized university diploma in accounting or in finance. The financially literate
variable (BoardComp) is the number of directors with an MBA or a BAA in administration or with
experience in finance or in accounting.

In sum, in as much as they are presumed to contribute to the independence and competence of the
board, we expect that the features mentioned above and represented in Figure 2 (H1) will on average, be
negatively associated with firms LNC. Furthermore, considering the likely synergy and interdependence
between CG variables (Cohen et al., 2004), they need to be aggregated to measure the boards
effectiveness. Therefore, we develop a score (Score_Board) as in Abbott et al. (2000) to proxy for the
level of effectiveness, or the extent to which Board characteristics are in compliance with best governance
practices. This score takes the value of (3), when the position of CEO is separated from the position of
Chairperson (COB); when the percentage of unrelated directors is greater than 50%; and when board
membership includes financial expert(s). Score_Board takes the value of (1), if the CEO is also the COB;
if the percentage of unrelated directors is lower than 50%; and if board membership does not include
financial expert(s). Finally, this score is equal to (2) in all other cases. Score_Board is used to empirically
test the following hypothesis, in alternate form:

H1: The boards effectiveness is negatively associated with the seriousness or level of non compliance of
accounting irregularities.

As suggested by McMullen (1996: 101), we examine the effectiveness of the audit committee by
looking at its characteristics. Abbott et al. (2004), Farber (2005) and Marciukaityte et al. (2005) find that
the competence and independence of the audit committee is negatively associated with the occurrence of
accounting irregularities. Agrawal and Chadha (2005) and Abbott et al. (2004) suggest a negative relation
between the presence of financial experts in the audit committee and the occurrence of restatements.
Compared to matched control firms, Farber (2005) shows that fraudulent firms have a lower proportion of
financial experts on their audit committees. Consistent with previous studies, we suggest that the
proportion of independent directors and financial experts is negatively associated with the non-compliance
level. We therefore develop a score for the audit committees effectiveness (Score_Audit) equal to (3), if

10
the percentage of unrelated directors on the audit committee exceeds 75% and if there is at least one
financial expert on the audit committee. This score is equal to (1), when the percentage of unrelated drops
below 75% and when there is no financial expert. And, finally, this score is (2) in all other cases.
Score_Audit is used to test the following hypothesis:

H2: The audit committees effectiveness is negatively associated with the seriousness or level of non
compliance of accounting irregularities.

3.2 Auditor effectiveness

The auditor also plays a crucial role in preventing and detecting accounting irregularities. Previous
studies show that the presence of a Big 4 auditor, a proxy for audit quality, is negatively associated with
the occurrence of accounting irregularities (Farber, 2005; Sennetti and Turner, 2001). Farber (2005)
indicates that fraudulent firms are, on average, less often audited by one of the Big 4 auditors as compared
to their matching control firms. Piot and Janin (2005) also find that the occurrence of a restatement is
often preceded by (positively associated with) a change of auditor. We combine these variables into a
score for auditor effectiveness (Score_Auditor) equal to (3), if the auditor is a Big 4 and if there is no
change in auditor in the year preceding default detection by the OSC; equal to (1), if the auditor is not a
Big 4 and if there is a change of auditor, and equal to (2) in all other cases. Score_Auditor is used to test
the following hypothesis:

H3: The auditors effectiveness is negatively associated with the seriousness or level of non compliance of
accounting irregularities.

3.3 Interaction of Corporate governance mechanisms

As suggested by Cohen et al. (2004), Bushman and Smith (2001) and Molz (1995), rather than
only examining individual board (Beasley, 1996), audit committee (Abbott et al., 2000 and 2004) or
auditor (Carcello and Nagy, 2004) characteristics, we also consider governance as a system by combining
these characteristics into scores and interaction terms in the empirical model. So, in a first step, as in prior
research, partial models are used to determine whether individual CG mechanisms are negatively related
to the seriousness of accounting irregularities. In a second step, full or integrative models are used to study
the effect of governance as a system. We hypothesize that the synergy or interaction between CG
mechanisms may prevent accounting irregularities:

11
H4: The interaction between the effectiveness of the board of directors, its audit committee, and the
auditor is negatively associated with the seriousness or level of non compliance of accounting
irregularities.

4. Research design

This section presents the sample selection and model development processes and defines the
dependent, independent and control variables of the various models used. Table 1 presents the
characteristics of the sample studied and table 2 summarizes and defines the variables.

4.1 Sample selection and description of the dependent variable

This study examines the extent to which CG acts as an effective means of investor protection
against accounting irregularities. The OSC, as the major securities market administrator in Canada, is
responsible for enforcing good reporting practices under its policies 51-601 and 57-603. So, the initial
sample consists of all the 425 firms which, as of the 10th of March 2005, were identified by the OSC as
reporting issuers in default (RID) for one of the failures to comply listed in Appendix 1. To focus on
accounting irregularities, we ignore defaults other than those related to AI in financial statements. As
shown in Table 1, panel A, the final RID sample is composed of the 107 nonfinancial firms listed on the
TSX or on the TSX Venture declared in default of the accounting irregularities defined as default H in
Appendix 1, for which data were available. Financial firms were eliminated because they are subject to
different regulations. From 107 RID detected for an accounting irregularity in their financial statements
(default H), 43 firms restated and re-filed their financial statements. 64 remained under investigation and
were imposed a CTO because they were not able or did not accept to satisfy the OSC requirements.
Among these CTO firms, 11 were imposed an enforcement action because of fraudulent financial
statements.

We use the severity of the sanctions imposed to these RID by the OSC to develop an LNC
measure as shown in the central portion of the conceptual framework presented in Figure 2. In other
words, we use the list of RIDs to identify financial reporting defaults of various levels of gravity, along
with their corresponding OSC disciplinary sanctions. As in Beasley (1996, p. 450), each of these issuers in
default is matched with a non-RID based on the following characteristics:

12
1. Industry: All RID are matched with a non-RID firm within the same industry.
2. Size: For each RID, we select a non-RID firm in the same size category4.
3. Stock Exchange: RID and matched non-RID shares must be traded on the same stock exchange, either
the Toronto or the TSX Venture exchange.
4. Time period: A non-RID firm is included in the final control sample if a proxy statement is available
on SEDAR for the same year the RID firm was cited as being in default.

Corporate governance data were collected from proxy statements. Financial information was
collected from Mergent Online and Corporate Retriever databases. The information regarding financial
and accounting expertise was collected from the FRinformat database and the Canadian Business edition
of Whos Who.

Panel B of Table 1 indicates that RID firms are clustered in the mining, technology and service
industries. This is consistent with prior research which indicates that accounting irregularities are more
prevalent in more volatile industries (Gerety and Lehn, 1997; Sennetti and Turner, 2001; Farber; 2005).
Panel C of Table 1 shows that 44% of RID firms are small. These results mirror those of Kinney and
McDaniel (1989) and Sennetti and Turner (2001), who interpret this as meaning that small firms have
fewer formal procedures of internal control.

[Insert Table 1 around here]

4.2 Multivariate model

We use an ordinal logit regression model to test our hypotheses because the dependent variable,
the level of non-compliance (LNC) of accounting irregularities, is an ordered categorical variable. LNC
takes the value of 0 for matching firms, 1 for restatement firms, 2 for CTO firms and 3 for firms subject to
enforcement actions because of fraudulent financial statements. Table 2 summarizes and defines the
variables used in the model.

The following partial models (PM) are used to test the hypothesised relations between the level of
non compliance of AI and the individual board of directors (H1), audit committee (H2) and auditor (H3)

4
We used the same six size categories as in SEDAR: less than 5 millions in assets, between 5 and 25 millions,
between 25 and 100 millions, between 100 and 500 millions, between 500 millions and 1 billion, and more than 1
billion.

13
characteristics. In the PM1 model, we examine the proportion of independent directors (Unrelated) and
financial experts on the board (BoardExpert), the directors ownership (OwnerBoard), the duality
functions of the CEO (CEO=COB), the presence of a block holder (BlockinBoard) and the number of
directorships in other firms (Nseats). Three control variables are also included. First, we expect firms also
listed in the US (USA) to be less likely not to comply than other firms listed only in Canada because of the
more stringent regulations in the US. Second, Dechow et al. (1996) find that fraudulent firms are likely to
have greater financing needs then control firms. We use the same variable (Financing) as them to control
for RID financing requirements, i.e. the announcement of a private placement in the year preceding
default. The underlying hypothesis is that RID are less likely to be in a position to return to the public
market to fulfill their needs. Third, the variable (OwnerBlock) is used to control for ownership
concentration.

LNCi=0 +1Unrelatedi+2OwnerBoardi+3BoardExperti (PM1)

+4(CEO=COB)i+5BlockinBoardi+6Nseatsi+7USAi+8Financingi+
9OwnerBlocki+i

In the second partial model, PM2, we test the hypothesized relation between the audit committee
and the level of non compliance of AI (H2). We examine the proportion of unrelated directors
(UnrelatedAudit), their financial expertise (AuditExpert) and financial literacy (AuditComp), the presence
of a non affiliated block holder (BlockinAudit) on the audit committee and its size (AuditSize). The control
variables remain the same.

LNCi =0+1UnrelatedAuditi+2AuditExperti+3BlockinAuditi
(PM2)
+4AuditSizei+5AuditCompi +6USAi+7Financingi+8OwnerBlock i+i

Finally, we test the hypothesized relations between the quality of the auditor and LNC in model
PM3. We examine whether the reputation and a recent change of auditor may be related to the seriousness
of accounting irregularities. The control variables remain the same.

LNCi =0+1Big 4i+2ChangeAuditori+3USAi+4Financingi +5OwnerBlock i+i (PM3)

The preceding partial models separately examine the impact of a single CG mechanism on the
level of non compliance. We also use full models (FM) to examine whether CG mechanisms work as a
system. Model FM1 examines whether board, audit committee and auditor characteristics affect LNC. In
FM2, we introduce an interaction term into FM1 between the percentage of independent directors on the

14
audit committee and the presence of a Big 4 auditor (UnrelatedAudit*Big4). This model allows us to test
H4 in Figure 2. In FM1 and FM2, we control for CEO ownership5, USA listing and financing needs.

Level of Non-Compliancei =0+1Unrelatedi+2BoardExperti+3(CEO=COB)i+4 (FM1)

BlockinBoardi+5UnrelatedAuditi+6AuditExperti+7Big4i+8ChangeAuditori+9
OwnerCeoi+10(OwnerCeoi)2 +11USAi+12 Financingi + i

Level of Non-Compliancei =0+1Unrelatedi+2BoardExperti+3(CEO=COB)i+4

BlockinBoardi+5UnrelatedAuditi+6AuditExperti+7Big4i+8ChangeAuditori+9 (FM2)
OwnerCeoi+10(OwnerCeoi)2+11(UnrelatedAudit*Big4)+12USAi+13Financingi +i

In FM3 and FM4, we aggregate the CG mechanisms in scores and interactive terms as described
earlier to examine the presumed relationship between the CG system and the level of non compliance.

Level of Non-Compliancei = 0+1Score_Auditi+2Score_Auditori+3

Score_Auditi*Score_Auditori+4USAi +5OwnerBlocki +6Financingi +i (FM3)

Level of Non-Compliancei = 0+1Score_Boardi+2Score_Auditi+3

Score_Auditori+4Score_Boardi*Score_Auditori+5USAi+6Financingi (FM4)
+7 Score_Auditi*Score_Auditori+8 OwnerBlocki+i

[Insert Table 2 around here]

5. Results and analyses

In this section, the characteristics of reporting issuers in default (RID) are first described and
univariate analyses are used to compare RID to non-RID firms. We then present the correlation matrices
between governance and control variables and the level of non compliance of accounting irregularities.
Finally, the results of the multivariate analyses are discussed followed by a discussion of the results of the
sensitivity analyses.

Descriptive statistics and univariate analyses

As a first test of hypothesis, we conduct univariate tests comparing the average CG profile of RID
firms to that of a matched control sample of non-RID firms. To measure the effectiveness or quality of

5. Hermalin and Weisbach (1988) and Chung and Pruitt (1995) show that the relation between CEO ownership and
performance is curvilinear. We presume that the same relation exists with LNC. Indeed, an increase in CEO
ownership may initially align interests and consequently be associated with a reduction in the seriousness of
accounting irregularities. However, past a certain ownership threshold, entrenchment may set in and facilitate
fraudulent behaviour.

15
those mechanisms, we used CG standards generally accepted as best practices by regulators and market
participants. Panel 1 of Table 3 presents descriptive statistics and results in relation to H1 in Figure 2.
Consistent with Persons (2005) findings and our hypothesis, it shows that 67 % of RID CEOs are also
COBs as compared to 20% for Non-RID. This difference is statistically significant at the 1 % level
(t=5.843). There is no significant difference in the average percentage ownership of directors
(OwnerBoard) which is between 25% and 30%. Panel 1 also documents that, as expected, the proportion
of unrelated directors (Unrelated = 36%) in RID firms is significantly smaller (1 % level; t=-4.337) than
the proportion in non-RID firms at 50%. Compared to non-RID, RID also have fewer non affiliated block
holders (BlockinBoard) and financial experts. Instead of experts, they seem to turn to financially literate
directors on their board of directors. This preliminary result indicates that having financial experts rather
than just financially literate board members seems to be more effective in lowering the occurrence of
accounting irregularities.

Panel 2 of Table 3 indicates that the audit committee is on average composed of 3 directors.
Regarding the audit committees effectiveness (H2, Figure 2), as expected, the percentage of independent
directors sitting on this committee is lower (56 %) compared to control firms (65%). The difference is
significant at the 10 % level. RID firms have 0.39 financial experts on their audit committee compared to
0.66 in control firms, which is also significant at the 5 % level. Contrasting with the directives of the OSC
multilateral instrument 52-110, only 13% of audit committee members are financial experts (AuditExpert)
and 28% are financially literate (AuditComp). This finding is consistent with Farber (2005), who finds that
fraudulent firms have an average of 0.46 financial experts on their audit committee.

Results reported in Panel 3 show that there is no statistical difference between RID and control
firms as far as CEO share ownership is concerned. This result is consistent with the findings of Agrawal
and Chadha (2005) and Baber et al. (2005). But, there is a statistically significant difference at the 5 %
level in the average tenure of the CEO, respectively 8 and 5 years in the case of RID and Non-RID firms.

Panel 4 indicates that 37 % of RID are audited by a Big 4 firm as compared to 43% in the case of
control firms, but the difference is not significant. This result is consistent with the findings of McMullen
(1996), DeFond and Jiambalvo (1991) and Baber et al. (2005). It is interesting to note that a large
proportion of RID have changed auditors in the year preceding default detection. In fact, 24% of RID have
done so as compared to only 4% for Non-RID. This in itself may constitute an important red flag for
fraud detection purposes.

16
 Finally, Panel 5 reports comparative statistics for various control variables. In brief, RID firms
appear to have a significantly lower proportion of shares held by block holders (32 % versus 38 %). The
difference is statistically significant at the 1% level. If we single out institutional ownership (8,5 %), the
proportion is also lower but the difference is not significant. We also find that 23% of RID as compared to
4% of Non-RID had planned to issue a private placement before being cited for default and that Canadian
firms listed in the US are less likely to be listed as RID. Consistent with Kinney and McDaniel (1989) and
Persons (1995), the debt ratio of RID is high at 1.19 times equity. Our investigation also shows that 22%
of RID foresee they will have recourse to a private placement in their proxy statements in the year
preceding default detection. Finally, they are clustered in the mining, technology and service industries; 20
% are also listed on a US stock market and 28% are listed on the TSX Venture. In sum, these preliminary
univariate analyses indicate that RID firms have less efficient individual CG mechanisms than do Non-
RID ones.
[Insert Table 3 around here]

In line with the conceptual framework of Figure 2, we now test whether differences persist when
we segregate the RID sample into sub samples according to the gravity of the default as defined in Figure
1. Panel 1 of Table 4 provides comparative statistics for the board of directors characteristics. The
comparison reveals that in 71% of the firms that restates their financial statements and are allowed to re-
file, the CEO is also the president of the board of directors as compared to only 14% in control firms. This
difference is statistically significant at the 1 % level (t=5.279). The board and audit committees of these
firms are generally composed of internal or affiliated directors and do not benefit from the presence of non
affiliated block holders. In addition, a majority of restatement firms have changed auditors one year before
the default detection and plan to fill their financing needs by means of a private placement. Results also
show that 20% of restatement firms are listed in the US as compared to 34% in the case of control firms.
There is no significant difference as far as the presence of financial experts on the board and audit
committee is concerned.

The comparison between CTO and matching firms shows that they have a lower proportion of
independent directors and financial experts on their boards and audit committees. At 31 %, the proportion
of shares held by block holders in CTO is 6 percentage points lower than in control firms at 37%. Finally,
results also show that fraudulent firms, the highest level of non compliance, have lower proportions of
independent directors and financial experts on their boards and audit committees. Fraudulent firms have
an average of 0.45 financial expert on their audit committee as compared to 1 expert in control firms, a
statistically significant difference at the 10 % level (t=-1.725). This result is consistent with Farber (2005).

17
As in Persons (2005), we also noticed that, in a majority of fraudulent firms, the CEO is also the
chairperson of the board. However, there is no statistically significant difference with regards to the USA,
Financing and OwnerBlock variables. In general, the above differences are in line with the hypotheses
summarized in our conceptual framework.

[Insert Table 4 around here]

Before we turn to our main objective which is to determine whether the gravity of the accounting
irregularities is negatively related to the efficiency of the CG system, we conduct correlation tests to
determine if there is unduly high correlation between these variables. Table 5 presents the correlation
matrices between continuous variables. Panel 1 of Table 5 contains the correlation matrix between the
level of non-compliance (LNC) and variables relative to the board of directors and the CEO. These
preliminary univariate statistics show that the level of non compliance is negatively associated with the
number of non affiliated block holders on the board of directors (BlockinBoard), the percentage of
unrelated directors (Unrelated), and the percentage of financial experts present on the board
(BoardExpert). Quite the reverse, LNC is positively correlated to the tenure of CEO (TenureCeo) and to
the combined CEO/COB positions (CEO=COB). Panel 2 of Table 5 indicates that LNC is negatively
associated with the percentage of unrelated members (UnrelatedAudit) and financial experts (AuditExpert)
on the audit committee. Finally, a change in auditor is positively associated with LNC. The table
presenting the correlation coefficients among the variables shows they are not too high to be used
simultaneously in multivariate analyses.

[Insert table 5 around here]

Multivariate analysis

Table 6 provides multivariate results from the estimation of the partial and full models of the
assumed relation between CG and the level of non-compliance or seriousness of accounting irregularities.

Effectiveness of individual corporate governance mechanisms

In accordance with hypothesis 1 (H1, Figure 2), results provided from the partial model PM1
presented in the third column of Table 6 show that an independent board is more likely to prevent

18
accounting irregularities and limit their seriousness. Indeed, the likelihood of financial fraud is higher
when the CEO is also the Chairman of the board (4 = 0.991, p <0.001) and when the board is composed
of a majority of affiliated or internal directors (1=-2.218, p<0.05). These results are consistent with
Marciukaityte et al. (2006) and Farber (2005) findings. They also show that the number of non affiliated
block holders on the board is negatively associated with LNC (5= -0.593, p<0.1). But, BoardExpert,
OwnerBoard and Nseats coefficients are not significant. In sum, we may conclude from PM1, that an
independent board is an important factor in the prevention of accounting irregularities and in minimizing
their gravity. This result supports the widely held belief of regulators in Canada and elsewhere in the
world (He et al., 2007) that the presence of unrelated directors on the board and the separation of the CEO
and COB positions are important factors of financial reporting quality.

In the next column, PM2 shows, as hypothesized, that the number of financial experts on the audit
committee is negatively associated with LNC (2=-0.776, p<0.001). But the coefficient of AuditComp
standing for financial literacy is not significant. This does not support the current Canadian policy (MI 52-
110), which just recommends the presence of financially literate members on the audit committee rather
than a financial expert as in the US. This result suggests that the policy should be tightened to match the
Sarbanes Oxleys requirement of the presence of a financial expert on the audit committee.

The estimation of the last partial model, PM3 (col. 5) shows that a change of auditor is positively
associated with LNC (2=0.614, p<0.1). This is consistent with the findings of Piot and Janin (2005) and
Knapp (1991). Furthermore, consistent with Dechow et al. (1996) and Baber et al. (2005), the coefficient
of Big 4 is not significant.

Effectiveness of corporate governance as a system

In the next 4 columns of table 6, four full models (FM1, FM2, FM3 and FM4) are developed to
determine whether an efficient CG system may negatively affect the gravity of the accounting
irregularities committed. These models test simultaneously the effect of the board of directors, the audit
committee and the auditor on the LNC. In general, results from FM1 confirm those obtained from partial
models. Accounting irregularities are more severe when (1) the CEO is also the president of the board, (2)
the board is mainly composed of internal and affiliated directors, (3) there are no non affiliated block
holders on the board, (4) the board and the audit committees are deprived of financial experts, and (5) the
firm has recently changed its auditor.

19
 As the effectiveness of CG mechanisms probably comes at least in part from their
interdependence, we introduce an interaction term in the FM2, FM3 and FM4 models to examine the
presumed synergy or interdependence between the board of directors, the audit committee and the auditor.
Model FM4 confirms that collaboration between a big 4 auditor and the audit committee, as measured by
the coefficient of UnrelatedAudit*Big4 which is significant at the 10 % level, may limit the level of
gravity of accounting irregularities (H4, Figure 2). In comparing models FM1 to FM2, we also notice that
the introduction of the interaction term has improved the explanatory power of the initial model. The
model explanatory power as measured by the Akaike information criteria (AIC) is better for FM2 than for
FM1. Besides, models FM3 and FM4 show that the coefficient of the interaction term
Score_Audit*Score_Auditor is negative and significant. The coefficient of Score_Audit is also significant.
These last results suggest that the effectiveness of the auditor can reinforce the effectiveness of the audit
committee in lowering the level of seriousness of accounting irregularities. Thus, our results generally
show that the interdependence between CG mechanisms can limit the gravity of accounting irregularities.

[Insert Table 6 around here]

Sensitivity analyses

To validate the robustness of the results obtained, we conducted some sensitivity analyses. We
first reproduced the results of the univariate analyses presented in Table 3 after eliminating TSX venture
firms. In fact, firms listed in TSX Venture are in general smaller and have less independent directors in
their board and the CEO is also the chairman. These firms may be under less pressure than those listed on
the TSX to follow the CG practices recommended by regulators, institutional investors and other
interested parties. Results can be biased by the presence of these firms in the sample. As shown in Table 7,
results are approximately the same except for the variables BlockinBoard, BoardExpert, OwnerBlock and
USA which are less significant because TSX venture firms are smaller than TSX firms.

[Insert Table 7 around here]

The use of the ordinal logit requires examining the parallel assumption hypothesis of this method6.
This hypothesis is rejected for models PM3 and FM3. Results are in general the same as those presented in
Table 6 when we use the non-proportional odds method, which relaxes the parallel assumption as
shown in Table 8.

6. We use SAS. In that statistical software, the parallel assumption is an anti-conservative test (Harrell, 2001).

20
 [Insert Table 8 around here]

Finally, to further examine the robustness of our results, we simplified our measure of the level of
non compliance by combining RID which were imposed a CTO with those who face enforcement actions
for fraudulent financial statements. So the dependent variable LNC remains at 0 for matching firms.
Restatements become 1 and CTO and fraudulent firms become 2. Results shown in Table 9 are
approximately the same as presented in Table 6.

[Insert Table 9 around here]

6. Conclusion

This study examines the extent to which corporate governance (CG) acts as an efficient means of
protecting investors against making erroneous inferences due to accounting irregularities. It does so by
testing the prediction that not only the occurrence of such irregularities but also their seriousness or level
of non compliance with market authorities financial statements filing requirements (FSFR) are negatively
associated with the quality of the CG system. Our main contribution stems from the fact that a broad array
of accounting irregularities and governance practices, as well as their interdependence, are taken into
consideration rather than focusing on a particular aspect of governance or a specific type of irregularity
such as restatement or fraudulent financial statements.

To identify these accounting irregularities and their gravity, a novel set of data on reporting
issuers in default (RID) is used. Accounting irregularities are exhaustively examined by using the list of
all Canadian reporting issuers found to be at fault with regard to various Ontario Securities Commission
FSFR. This tracking and enforcement system is maintained by the Canadian Securities Administrators
(CSA), a body which includes the OSC. Depending on their gravity, these failures to comply lead to more
or less severe OSC sanctions. These disciplinary actions range from having to re-file and being maintained
on a Re-filing and errors List, when the firm accepts to restate, to a cease trade order when the firm
cannot comply and remains under investigation, of worse, to an enforcement action when the firm is
found guilty of producing fraudulent financial statements. A sample of 107 firms identified as reporting
issuers in default (RID) by the OSC is matched with 107 control firms based on industry, size, stock
exchange membership and date of default.

21
 Consistent with prior research, we first find that the occurrence of accounting irregularities is
negatively associated with the quality of corporate governance. Specifically, results of univariate analyses
indicate that issuers in default have less effective boards, audit committees, and auditors as benchmarked
against best practices than the matched control group. Our main contribution resides in our multivariate
tests of the relation between corporate governance as a system and the gravity of accounting irregularities.
The level of non compliance of accounting irregularities is indeed higher when firms: (1) have fewer
independent directors on their boards and audit committees and no block holder, (2) have recently
changed auditors, (3) have a CEO who is also the Chairperson, and (4) show poor communication
between their audit committee and their auditor, while having large financing requirements.

This study makes several contributions to the literatures on governance, on fraudulent financial
statements and on the public enforcement of securities laws by market authorities (La Porta et al., 2006;
Palmrose, 1999). It extends research on the presumed negative link between CG and financial reporting
failures by taking into account their relative degree of non compliance with FSFR. Furthermore, previous
research on enforcement actions has been conducted almost exclusively in the US. It has recently become
difficult to conduct that kind of research in the US as governance practices are more strictly regulated
since the adoption of SOX. The use of a more principle-based institutional setting with regard to
governance practices leaves more latitude to management in the choice of governance practices and
allows for the variability needed to conduct statistical analyses. The ultimate objective is to help policy
makers and national securities administrators improve their investigative power through a better
understanding of the CG characteristics of potential issuers in default of financial statement filing
requirements.

For the purpose of this study, we focused on a sub sample of the financial reporting failures
tracked by the OSC. This data bank on reporting issuers in default could also be used to examine the
determinants of other kinds of deficiencies and enforcement actions, presented in the appendix. For
instance, it would be interesting to study the relation between corporate governance and the failure to
disclose on the part of insiders. Or one could examine if accounting violations are more likely to bring the
firms to change their CG system after being identified as reporting in default.

22
 Figure 1

OSC tracking and enforcement system of reporting issuers in default

Default Corrections to the

satisfaction of the OSC OSC Disciplinary sanctions*

(1) (2) (3)

Issuer restates
Reporting issuer Yes and re-files:
identified as in put on the
Managers Enforcement
default (RID) put Re-filing and
and insiders action because
on the RID list. Financial errors list
cease trade of fraudulent
statements
order financial
Corrections defaults (H)
(M&I- CTO) statements
imposed. No

Other Cease trade

defaults order for all
(CTO)

*Three levels of sanctions are imposed according to the gravity of the accounting irregularity detected by the OSC.
Level (2) indicates that the RID remains under investigation.

23
 Figure 2
Conceptual framework of the relationship between the CG system and the level of non compliance

Control Variables Corporate governance system

Dependent Variable
Level of non compliance Board of directors
(LNC) of accounting
Block ownership (-) irregularities (-) Independence
Meetings
H1
Institutional (-) Restatement (-) Financial experts
ownership
(+) Number of
directorships
Financing (+) Cease trade
requirements order
H4 (+) CEO Duality

Size (-) Insider

Enforcement actions (+) Ownership
for fraudulent
financial statements
Debt (+)
Audit committee

(-) Independence
H2
(-) Size

(-) Financial experts

CEO

(+/-) Ownership

(+) Tenure

Auditor

H3 (-) Reputation
LNC: The three levels of non-compliance (LNC) presented
in this figure correspond to the OSCs disciplinary
(-) Change
sanctions (1) restatement, (2) CTO, and (3)
enforcement actions in figure 1.

(+/-): Indicates the expected sign of the relation.

24
 Table 1
Reporting issuers in default (RID) sample selection and characteristics

Panel A : RID sample selection

Description Number
of RID
Initial sample as of March 10th, 2005 425
Exclusion of defaults other than accounting irregularities
described in category H of Appendix 1 (268)
Proxy statement not available on SEDAR one year before the
default detection (7)
Exclusion of financial firms (43)
Final sample 107

Panel B : Distribution of RID by industry

Industry Percentage of RID

Mines 22.24%
Technologies 25.23%
Services 17.75%
Others 34.57%
Total 100%

Panel C : Distribution of RID by size

Assets Percentage of RID

Less than 5 millions 44%
Between 5 and 25 millions 36%
Between 25 and 100 millions 10%
100 millions and over 10%
Total 100%

25
 Table 2
Variables definition

Variables Description Expected

Sign

Dependent Variable
Level of non- Measured by the level of sanction imposed according to OSC
Compliance (LNC) policies 51-601 & 57-607. Equals 1 for a restatement or a default
corrected to the OSCs satisfaction, 2 for CTOs and 3 for
enforcement actions following the discovery of fraudulent
financial statements as per Figure 1.

Independent Variables

Board of directors
BoardSize Size of the board ?
Unrelated Percentage of unrelated directors -
OwnerBoard Percentage of shares held by directors ?
OwnerInsiders Percentage of shares held by insiders and affiliated directors +
BlockinBoard Number of non affiliated block holders -
Nseats Number of directorships held in other firms +
BoardExpert Number of financial (or accounting) experts on the board -
BoardComp Number of directors with some knowledge of finance or -
accounting (financial literacy)
CEO=COB Combined CEO / COB positions +
Score_Board 3, when CEO is not the COB, the percentage of unrelated is more -
than 50%, and at least one financial expert is present on the
board; 1, when CEO = COB, percentage of unrelated is less than
50%, absence of a financial expert; 2, in other cases

Audit committee
AuditSize Audit committee size -
UnrelatedAudit Percentage of unrelated members -
AuditExpert Number of financial (or accounting) experts -
AuditComp Number of members with some knowledge of finance or -
accounting (financial literacy)
BlockinAudit Number of non affiliated block holders on audit committee -
Score_Audit 3, when percentage of unrelated is more than 75% and at least -
one financial expert is present on the audit committee; 1, when
the percentage of unrelated is less than 75% and absence of a
financial expert; 2, in all other cases.

26
 Table 2 (Continued)

Variables Description Expected

Sign

CEO
OwnerCeo Percentage of shares held by the CEO +/-
TenureCeo CEO tenure as measured by the number of years a CEO is in
office +

Auditor
Big4 Equal to 1 if the auditor is part of the Big 4, 0 otherwise -

ChangeAuditor Equal to 1 if we observe a change of auditor, 0 otherwise +

Score_Auditor 3, when auditor is Big 4 and the firm doesnt change the auditor; -
1, when the auditor is not a Big 4 and the firm changes auditor; 2,
in other cases.

Control Variables
Block Ownership -
OwnerBlock Percentage of shares held by block holders (+10%)
OwnerInstit Percentage of shares held by institutional investors -
Financing needs Announcement of a private placement in the proxy statement +
in the year preceding default
Debt Debt level (total debt / total asset) +
Size Firm size (total asset) -
IND Industry (mine, technology or services) ?
USA Equal to 1 if a firm is listed in the USA and 0 otherwise -
TSX Venture Equal to 1 if a firm is listed on the TSX Venture and 0 otherwise +

27
 Table 3
Univariate mean comparisons of reporting issuers in default (RID) and Non-RID firms

Variables Minimum Maximum RID Non-RID t-stat

Control
firms

Panel 1 : Board of directors

CEO=COB 0 1 0.67 0.20 (5.843)***
OwnerBoard 0 0.7856 0.2553 0.3070 -1.206
Unrelated 0 0.8571 0.3631 0.4985 (-4.337)***
BlockinBoard 0 2 0.23 0.27 (-1.552)*
Nseats 0 3 0.60 0.75 -1.014
BoardSize 3 13 5.48 5.94 -1.162
BoardComp 0 6 2.10 1.84 0.901
BoardExpert 0 4 0.55 0.85 (-1.733)*
%BoardComp 0 1 0.39 0.29 (2.422)**
%BoardExpert 0 0,6667 0.10 0.12 -0.73

Panel 2 : Audit committee

AuditSize 0 5 2.83 2.63 1.059
BlockinAudit 0 1 0.13 0.13 0.00
UnrelatedAudit 0 1 0.56 0.65 (-1.686)*
AuditComp 0 4 0.79 0.77 0.093
AuditExpert 0 2 0.39 0.66 (-2.165)**
%AuditComp 0 1 0.28 0.31 -0.353
%AuditExpert 0 1 0.13 0.16 (-1.687)*

Panel 3 : CEO
OwnerCeo 0 0.782 0.1457 0.1550 -0.243
TenureCeo 0 48 8.54 5.75 (2.425)**

Panel 4 : Auditor
Big 4 0 1 0.37 0.43 -0.683
ChangeAuditor 0 1 0.24 0.04 (3.166)***

Panel 5 : Other variables

OwnerInstit 0 0,9472 0.0851 0.0941 -0.196
OwnerBlock 0 1 0.3234 0.3845 (-1.519)*
Financing 0 1 0.23 0.04 (3.166)***
USA 0 1 0.20 0.34 (-1.926)**
***, **, *: Significant at 1%, 5% and at 10 %, respectively.
Note:
OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB position. Nseats:
number of directorships held in other firms. BlockinBoard: number of non affiliated block holders on board. Unrelated:
percentage of independent directors. OwnerBoard: percentage of shares held by directors. OwnerInsiders: percentage of shares
held by insiders. BoardSize: board size. BoardComp: number of directors with some knowledge of finance or accounting.
BoardExpert: number of financial or accounting experts %Boardcomp: percentage of BoardComp. %BoardExpert: percentage of
BoardExpert. BlockinAudit: number of non affiliated block holders on audit committee. AuditSize: audit size. UnrelatedAudit:
percentage of independent directors on audit committee. AuditComp: number of members with some knowledge of finance or
accounting. AuditExpert: number of financial experts on audit committee. %AuditComp: percentage of AuditComp.
%AuditExpert: percentage of AuditExpert. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its auditor one year before
default detection. OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of shares held by
block holders (more than 10%) Financing: firm plans to seek a private placement. USA: listed on a US stock market.

28
 Table 4
Comparisons of reporting issuers in default (RID) by level of non-compliance (LNC)

LEVEL 1 - Restatements or corrections LEVEL 2 CTO LEVEL 3 - Fraud

N = 43 N = 64 N = 11
Value of Control t-stat Value of Control firm t-stat Value Control t-stat
variable firm variable of firm
variable

Panel 1 : Board of directors

CEO=COB 0.71 0.14 (5.279)*** 0.55 0.21 (3.576)*** 0.55 0.27 (1.539)*
OwnerBoard 0.2364 0.3324 -1.263 0.2784 0.2622 0.304 0.3686 0.2953 0.551
Unrelated 0.31 0.51 (-4.772)*** 0.33 0.45 (-1.646)* 0.35 0.55 (-2.672)**
BlockinBoard 0.14 0.38 (-2.567)** 0.28 0.41 (-1.543)* 0.27 0.36 -0431
Nseats 0.73 0.56 1.362 0.44 0.50 -0.802 1.49 1.57 -0.909
BoardSize 5.38 5.28 0.227 5.38 5.28 0.228 8.73 9.27 -0.353
BoardComp 1.93 1.52 1.593 2.41 1.55 (2.327)** 2.90 3.90 (-1.464)*
BoardExpert 0.72 0.66 0.34 0.41 0.69 (-1.612)* 0.82 1.91 (-1.883)*

Panel 2 : Audit Committee

AuditSize 2.69 2.59 (2.942)* 2.92 2.36 (2.347)** 3.33 4 -1.125
BlockinAudit 0.14 0.11 0.328 0.14 0.21 -0.701 0 0 n.d
UnrelatedAudit 0.53 0.69 (-2.140)** 0.51 0.67 (-1.5603)* 0.59 0.70 (-1.992)*
AuditComp 0.59 0.66 -0.420 0.90 0.72 0.517 1.36 1.38 -0.132
AuditExpert 0.34 0.44 -0.101 0.31 0.55 (-1.574)* 0.45 1 (-1.725)*

Panel 3 : CEO
OwnerCEO 0.1462 0.1809 -0.525 0.1728 0.1349 1.277 0.2080 0.2126 -0.033
TenureCEO 8.24 5.83 (2.688)** 8.07 5.75 (1.769)** 11.18 5.82 1.248

Panel 4 : Auditor
Big 4 0.38 0.31 0.071 0.36 0.39 -0.297 0.64 0.82 -1.020
ChangeAuditor 0.28 0.10 (1.543)* 0.21 0 (2.703)** 0 0 n.d

Panel 5 : Other variables

OwnerInstit 0.076 0.090 -0.243 0.12 0.08 0.494 0.091 0.053 0.444
OwnerBlock 0.3136 0.3733 -1.127 0.3141 0.3717 (-1.581)* 0.59 0.43 1.145
Financing 0.20 0.05 (1.962)* 0.27 0.07 (2.274)** 0.09 0 1.010
USA 0.20 0.34 (-1.524)* 0.24 0.38 (-1.454)* 0.55 0.45 0.430

29
***, **, * Significant at 1%, 5% and at 10 %, respectively.
Note:

OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB position. Nseats: number of directorships held in
other firms. BlockinBoard: number of non affiliated block holders on board. Unrelated: percentage of independent directors. OwnerBoard: percentage of shares held
by directors. BoardSize: board size. BoardComp: number of directors with some knowledge of finance or accounting. BoardExpert: number of financial or
accounting experts. BlockinAudit: number of non affiliated block holders on audit committee. AuditSize: audit size. UnrelatedAudit: percentage of independent
directors on audit committee. AuditComp: number of members with some knowledge of finance or accounting. AuditExpert: number of financial experts on audit
committee. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its auditor one year before default detection. OwnerInstit: percentage of shares held by
institutional investors. OwnerBlock: percentage of shares held by block holders (more than 10%); Financing: firm plans to seek a private placement. USA: listed on
a US stock market.

30
 Table 5

Panel 1
Correlations matrix between LNC and board variables

Variables LNC OwnerCeo TenureCeo CEO=COB Nseats BlockinBoard Unrelated OwnerBoard BoardSize BoardComp BoardExpert
LNC 1 -0.009 (0.138)** (0.330)** -0.044 (-0.115)* (-0.193)*** -0.031 0.042 (0.180)* (-0.099)*
OwnerCeo 1 (0.320)*** 0.088 0.081 (-0.100)* 0.046 (0.757)*** 0.001 (-0.121)* (-0.120)*
TenureCeo 1 (0.197)*** 0.083 -0.081 -0.014 (0.197)*** 0.096 -0.057 (-0.126)**
CEO=COB 1 (0.222)* -0.076 (-0.213)*** -0.025 -0.070 -0.010 -0.096
Nseats 1 -0.062 (0.153)* -0.049 (0.217)** (0.281)** (0.251)**
BlockinBoard 1 (-0.137)* (0.365)* 0.001 0.072 -0.004
Unrelated 1 (-0.126)** (0.191)** 0.035 0.031
OwnerBoard 1 -0.034 (-0.079)* (-0.146)**
BoardSize 1 (0.464)*** (0.409)**
BoardComp 1 (0.464)**
BoardExpert 1

Panel 2
Correlations matrix between LNC, audit and control variables
Variables LNC BlockinAudit AuditSize Unrelated AuditComp AuditExpert Big 4 ChangeAudi OwnerBloc OwnerInstit Financing USA
Audit tor k
LNC 1 -0.057 (0.156)** (-0.135)* 0.091 (-0.158)* 0.062 (0.102)* 0.087 0.060 (0.183)* -0.025
BlockinAudit 1 0.032 (-0.327)** (0.167)* -0.078 -0.013 -0.026 (0.120)** -0.091 0.004 0.067
AuditSize 1 -0.002 (0.396)*** (0.286)*** (0.186)** 0.025 (0.176)** 0.086 0.009 (0.146)**
UnrelatedAudit 1 -0.067 0.065 0.088 -0.099 0.022 0.036 (-0.160)** (0.182)**
AuditComp 1 (0.195)** (0.153)** 0.008 (0.149)** 0.105 (-0.120)* (0.107)*
AuditExpert 1 (0.197)** -0.009 -0.017 0.010 -0.002 (0.218)**
Big4 1 -0.018 -0.042 0.074 0.026 (0.197)**
ChangeAuditor 1 (-0.132)* -0.091 0.013 -0.051
OwnerBlock 1 (0.330)*** 0.062 0.039
OwnerInstit 1 (0.162)* 0.031
Financing 1 -0.021
USA 1

31
 Table 5 (Continued)

Panel 3
Correlations matrix between other variables

Variables OwnerCeo TenureCeo CEO=COB Nseats BlockinBoard Unrelated OwnerBoard BoardSize BoardComp BoardExpert
BlockinAudit 0.012 -0.048 0.053 -0.076 (0.696)*** (-0.191)** (0.315)** (-0.146)* 0.012 -0.096
AuditSize (0.134)* 0.126 0.055 (0.217)* 0.001 (0.164)* 0.092 (0.222)** (0.237)** 0.088
UnrelatedAudit 0.021 0.085 -0.090 (0.157)* (-0.152)* (0.668)*** -0.071 (0.214)*** 0.072 (0.121)*
AuditComp 0.103 (0.148)* -0.058 0.136 0.072 -0.009 0.104 (0.244)** (0.563)*** 0.052
AuditExpert (-0.119)* -0.037 -0.057 (0.193)** -0.104 (0.133)* (-0.190)* (0.310)** (0.346)*** (0.648)***
Big4 (-0.129)* 0.015 0.084 (0.282)** 0.013 0.054 (-0.134)* (0.303)*** (0.278)** (0.220)**
ChangeAuditor 0001 -0.046 (0.167)** 0.018 (-0.131)* -0.049 -0.089 (-0.139)* -0.043 -0.082
OwnerBlock (0.391)** 0.076 0.028 0.092 (0.184)** -0.060 (0.499)*** (0.499)* 0.091 0.059
OwnerInstit -0.107 -0.003 -0.006 -0.015 -0.103 0.008 -0.176 0.041 0.053 -0.010
Financing 0.014 0.078 (0.246)** -0.010 -0.020 (-0.143)* -0.001 -0.065 -0.018 -0.018
USA (-0.136)* -0.018 -0.064 (0.239)*** 0.005 (0.185)* -0.105 0.335 (0.243)*** (0.239)***

***, **, * Significant at 1%, 5% and at 10 %, respectively.

Note :
LNC: level of non-compliance Level. OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB positions.
Nseats: number of directorships held in other firms. BlockinBoard: number of non affiliated block holders on board. Unrelated: percentage of independent directors.
OwnerBoard: percentage of shares held by directors. BoardSize: board size. BoardComp: number of directors with some knowledge of finance or accounting.
BoardExpert: number of financial or accounting experts. BlockinAudit: number of non affiliated block holders on audit committee. AuditSize: audit size.
UnrelatedAudit: percentage of independent directors on audit committee. AuditComp: number of members with some knowledge of finance or accounting.
AuditExpert: number of financial experts on audit committee. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its auditor one year before default detection.
OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of shares held by block holders (more than 10%) Financing: firm plans to
seek a private placement. USA: listed on a US stock market.

32
 Table 6
Relation between the System of CG and the level of non-compliance

This table provides results of multivariate analyses. We estimate partial models (PM1, PM2 and PM3) and full models (FM1,
FM2, FM3 and FM4). The dependent variable is calculated with the following formula:
P(Yi m ) K
Ln
P(Yi > m)
= m +

X , with m=0 to 3 and
=1
i m is the cut off point for m.

Predicted Partial models Full models

sign
PM1 PM2 PM3 FM1 FM2 FM3
(1) (2) (3) (4) (5) (6) (7) (8)
Constant 3 -2.424 -2.872 -3.195 -2.225 -2.799 -5.305 -
Constant 2 0.311 -0.828 -1.227 -0.170 -0.726 -3.306 -
Constant 1 0.3119 0.475 -0.018 1.240 0.702 -1.990 -
CEO=COB + (0.991)*** (0.886)*** (0.881)***
Unrelatd - (-2.218)** (-1.962)** (-1.937)**
BlockinBoard - (-0.593)* (-0.676)** (-0.629)*
BoardExpert - -0.503 -0.184 -0.176
Ownerboard ? -0.519
Nseats + -0.129
AuditSize - 0.142
UnrelatedAudit - -0.3794 0.227 1.081
AuditExpert - (-0.776)*** (-0.686)** (-0.749)***
AuditComp - 0.203
BlockinAudit - -0.419
Big4 - 0.207 0.432 (1..514)*
ChangeAuditor + (0.614)* 0.167 0.194
OwnerCeo + -0.098 0.246
OwnerCeo2 - -1.614 -1.852
Interaction - (-1.793)*
BIG_4*UnrelatedAudit
Score_Board - (-0
Score _Audit - (-1.395)* (-
Score_Auditor - 1.217
Score_Board*Score_Auditor - -
Score_Audit*Score_Auditor - (-0.753)** (-0
USA - -0.139 -0.041 -0.239 0.091 0.155 -0.365 -
Financing + 0.561 (0.619)* (0.959)* 0.072 0.111 (0.778)*
OwnerBlock - 0.437 0.057 0.435 0469

AIC 296.457 392.103 438.256 362.317 361.652 393.294 3

Gamma 0.412 0.177 0.236 0.396 0.409 0.206
Tau-b 0.266 0.121 0.161 0.271 0.281 0.140
Percent concordant 70.3 58.2 60.7 69.4 70.2 59.4
***, **, * Significant at 1%, 5% and at 10 %, respectively.
Note:
OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB positions. Nseats:
number of directorships held in other firms. BlockinBoard: number of non-affiliated block holders on board. Unrelated:
percentage of independent directors. OwnerBoard: percentage of shares held by directors. BoardSize: board size. BoardComp:
number of directors with some knowledge in finance of accounting. BoardExpert: number of financial or accounting experts.
BlockinAudit: number of non-affiliated block holders on audit committee. AuditSize: audit size. UnrelatedAudit: percentage of
independent directors on audit committee. AuditComp: number of members with some knowledge of finance or accounting.
AuditExpert: number of financial experts on audit committee. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its auditor

33
one year before default detection. OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of
shares held by block holders (more than 10%) Financing: firm plans to seek private placement. USA: listed on a US stock
market.

AIC: The Akaike information criterion is a measure of the explanatory power of the model for ordinal variable. Model with a
lower AIC has the best explanatory power.

Gamma. tau-b and percent concordant test for the ordinal association.

34
 Table 7
Sensitivity analysis : Univariate comparison of reporting issuers in default (RID) and Non-RID firms after eliminating TSX Venture firms
from the sample.
Variables Issuer in default Matching firm t-stat

Panel 1: Board of directors

CEO=COB 0.63 0.22 (4.214)***
OwnerBoard 0.2581 0.3293 -1.348
Unrelated 0.3705 0.5109 (-3.601)***
BlockinBoard 0.24 0.37 -1.309
Nseats 0.50 0.77 -1.523
BoardSize 5.71 5.85 -0.298
BoardComp 2.43 1.75 (2.032)**
BoardExpert 0.63 0.87 -1.037
%BoardComp 0.44 0.29 (3.219)**
%BoardExpert 0.122 0.129 -0.212

Panel 2: Audit committee

AuditSize 2.90 2.58 1.3219
BlockinAudit 0.10 0.14 -0.531
UnrelatedAudit 0.59 0.69 (-1.576)*
AuditComp 0.79 0.77 0.093
AuditExpert 0.46 0.52 (-1.612)*
%AuditComp 0.33 0.29 -0.643
%AuditExpert 0.14 0.16 (1.554)*

Panel 3: CEO
OwnerCEO 0.1413 0.1862 (0.361)
TenureCEO 8.87 5.83 (2.088)**

Panel 4: Auditor
Big 4 0.43 0.42 0.0512
ChangeBig4 0.23 0.04 (2.850)***

Panel 5: Other variables

OwnerInstit 0.1034 0.0500 1.259
OwnerBlock 0.3089 0.3776 -1.222
Financing 0.21 0.04 (2.635)**
USA 0.21 0.31 -1.093

35
***, **, *: Significant at 1%, 5% and at 10 %, respectively.
Note:
OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB position. Nseats: number of directorships held in
other firms. BlockinBoard: number of non affiliated block holders on board. Unrelated: percentage of independent directors. OwnerBoard: percentage of shares held
by directors. OwnerInsiders: percentage of shares held by insiders. BoardSize: board size. BoardComp: number of directors with some knowledge of finance or
accounting. BoardExpert: number of financial or accounting experts %Boardcomp: percentage of BoardComp. %BoardExpert: percentage of BoardExpert.
BlockinAudit: number of non affiliated block holders on audit committee. AuditSize: audit size. UnrelatedAudit: percentage of independent directors on audit
committee. AuditComp: number of members with some knowledge of finance or accounting. AuditExpert: number of financial experts on audit committee.
%AuditComp: percentage of AuditComp. %AuditExpert: percentage of AuditExpert. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its auditor one year
before default detection. OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of shares held by block holders (more than 10%)
Financing: firm plans to seek a private placement. USA: listed on a US stock market.

36
 Table 8
Sensitivity analyses : Generalized ordinal method

This table presents results using generalized ordinal method. In this method, we choose the sub-sample of fraudulent firms as a reference for comparison (m=3).

P ( y i = m) K
Ln
p( y i = 3)
=m +
=1

mk X i ; with m = (0,1,2,3)

Variables Board : PM2 Audit committee : PM3 Auditor : PM4

P(yi = 0) P( yi =1) P(yi = 2) P( yi = 0) P( yi = 1) P( yi = 2) P(y = 0) P(yi =1) P( yi = 2)

Ln Ln Ln Ln Ln Ln Ln i Ln Ln
P(yi = 3) P( yi = 3) P(yi = 3) P( yi = 3) P( yi = 3) P( yi = 3) P(yi = 3) P(yi = 3) P( yi = 3)

CEO=COB -0,916 (-1,477)** 0,673

Unrelated (5,214)*** 2,630 3,647
BlockinBoard (1,359)* 0,609 0,766
BoardExpert 0,355 -0,056 -0,270
AuditSize -0,741 -0,615 -0,650
UnrelatedAudit 1,304 0,250 1,170
AuditExpert (1,416)** 0,649 0,416
Big4 -0,839 (-1,157)* -0,907
ChangeBig4 (5,286)*** (7,057)*** (6,783)***
USA (-1,150)* (-1,163)** (-1,601)** -1,706 -2,403 -2,3255
OwnerBlock (-3,807)*** (-5,195)*** (-4,591)*** (-2,430)* (-3,710)*** (-3,399)** (-3,419)*** (-4,402)*** (-3,993)***
Financing -0,025 0,975 (1,651)* (7,708)*** (9,235)*** (9,402)*** -0,487 1,329 (1,642)*

37
 Table 8 (Continued)
FM 2 FM 3 FM4
Variables P(y = 0) P(y =1) P( yi = 2) P(y = 0) P(y =1) P(y = 2) P(yi = 0) P(y =1) P(y =2)
Ln i Ln i Ln Ln i Ln i Ln i Ln Ln i Ln i
P(yi = 3) P(yi =3) P( yi = 3) P(yi = 3) P(yi = 3) P(yi = 3) P(yi = 3) P(yi =3) P(yi =3)
CEO=COB 0.157 (-2.647)*** (-4.303)*

Unrelated (5.9289)** 2.048 2.642

BlockinBoard (1.858)* 0.772 0.638

BoardExpert 0.245 -0.142 -0.148

AuditSize -0.854 -0.030 -0.142

UnrelatedAudit -3.389 -1.788 -1.560

AuditExpert (1.711)* 0.873 0.566

Big 4 (-4.657)* -2.915 -2.504

Interaction (4.924)* 2.318 2.117

(UnrelatedAudit*Big4)
OwnerCeo -3.181 0.811 1.546

(OwnerCeo)2 6.150 -2.662 6.150

Score_Auditor -3.151 -2.411 -1.790 -3.489 -1.149 -1.217

Score_Auditor*Score_Board 0.396 -0.083 0.086 0.182 (0.750)** -0.224

Score_Audit -3.663 -2.222 -2.120 -3.777 -2.022 -1.911

Score_Audit*Score_Auditor 1.369 0.524 0.449 1.383 0.671 0.435

USA (-1.6504)** (-1.938)* (-1.859)* -0.735 -1.373 -1.975 -0.712 (-1.474)* (-1.919)**

OwnerBlock (-3.780)*** (-4.948)*** (-3.802)** (-3.434)* (-4.535)** (-3.782)* -3.782 (-4.304)** (-3.507)*

Financing -3.608 -4.453 -4.621

***. **. *: Significant at 1%. 5% and at 10 %. respectively.

38
 Note :
OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB positions. Nseats: number of
directorships held in other firms. BlockinBoard: number of non-affiliated block holders on board. Unrelated: percentage of independent directors.
OwnerBoard: percentage of shares held by directors. BoardSize: board size. BoardComp: number of directors with some knowledge in finance of
accounting. BoardExpert: number of financial or accounting experts. BlockinAudit: number of non-affiliated block holders on audit committee.
AuditSize: audit size. UnrelatedAudit: percentage of independent directors on audit committee. AuditComp: number of members with some knowledge
of finance or accounting. AuditExpert: number of financial experts on audit committee. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its
auditor one year before default detection. OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of shares held by
block holders (more than 10%) Financing: firm plans to seek private placement. USA: listed on a US stock market.

39
 Table 9
Sensitivity analyses : Level of non compliance

In this table, the dependent variable takes 0 for matching firms, 1 for restatement firms and 2 for CTO and fraudulent firms.

Predicted Partial models Full models

sign
PM2 PM3 PM4 FM1 FM2 FM3 FM4

Constante 2 0,223 (-1,144)** -0,854 -0,552 -0,966 -0,628 -3,57

Constante 1 (1,133)* 0,069 0,377 0,782 0,377 0,581 -2,232
CEO=COB + (1,105)*** (0,915)*** (0,912)***
Unrelated - (-2,078)** (-2,23)** (-2,223)**
BlockinBoard - (-0,648)* (-0,610** (-0,570)*
BoardExpert - -0,239 -0,267 -0,281
OwnerBard ? -0,369
Nsieges + -0,339
AuditSize - 0,070
UnrelatedAudit - -0,182 0,635 1,265
AuditExpert - (-0,257)* -0,078 -0,081
AuditComp - 0,129
BlockinAudit - -0,322
Big4 - 0,176 0,293 1,059
ChangeBig4 + (0,709)* 0,281 0,299
OwnerCeo + 0,437 0,648
(OwnerCeo) 2 - -2,453 -2,556
Interaction - (-,236)*
(BIG_4*UnrelatedAudit )
Score_Board -
Score _Audit - 0,585
Score_Auditor - 0,307 (-1,736)**
Score_Bord*Score_Auditor - (-0,222)** (-0,251)*
Score_Audit*Score_Auditor - (-0,761)*
USA - -0,285 -0,328 -0,267 -0,084 -0,048 -0,224 (-0,481)*
Financing + (0,829)* (1,135)** (0,801)* 0,393 0,429 (1,087)** (1,014)**
OwnerBlock - 0,172 0,220 -0,146 0,071 0,377

AIC 264,080 379,241 355,05 323,506 320156 380,140 341,22

Gamma 0,438 0,258 0,182 0,411 0,421 0,239 0,287
Tau-a 0,273 0,168 0,119 0,269 0,276 0,155 0,189
Percent concordant 71,61 61,9 58,5 70,3 70,9 60,6 63,8
***, **, * Significant at 1%, 5% and at 10 %, respectively.
Note:
OwnerCeo: percentage of shares held by CEO. TenureCeo: tenure of CEO. CEO=COB: combined CEO/COB positions. Nseats: number of
directorships held in other firms. BlockinBoard: number of non-affiliated block holders on board. Unrelated: percentage of independent directors.
OwnerBoard: percentage of shares held by directors. BoardSize: board size. BoardComp: number of directors with some knowledge in finance of
accounting. BoardExpert: number of financial or accounting experts. BlockinAudit: number of non-affiliated block holders on audit committee.
AuditSize: audit size. UnrelatedAudit: percentage of independent directors on audit committee. AuditComp: number of members with some knowledge
of finance or accounting. AuditExpert: number of financial experts on audit committee. Big 4: Big 4 auditor. ChangeAuditor: Firm has changed its
auditor one year before default detection. OwnerInstit: percentage of shares held by institutional investors. OwnerBlock: percentage of shares held by
block holders (more than 10%) Financing: firm plans to seek private placement. USA: listed on a US stock market.

AIC: The Akaike information criterion is a measure of the explanatory power of the model for ordinal variable. Model with a lower AIC has the best
explanatory power.

Gamma. tau-b and percent concordant test for the ordinal association.

40
 APPENDIX I
Default Description with regard to
the OSC Financial Statement Filing Requirements

Default Description
A a failure to file annual financial statements within the time periods prescribed by section 77 of
the Act and NI 51-102 Continuous Disclosure Obligations (NI 51-102) and NI 81-106
Investment Fund Continuous Disclosure (NI 81-106);
B a failure to file interim financial statements within the time periods prescribed by section 78 of
the Act and NI 51-102 and NI 81-106;
C a failure to file an annual or interim MD&A required by NI 51-102 or an annual or interim
management report of fund performance (MRFP) required by NI 81-106;
D a failure to file an AIF required by NI 51-102 and NI 81-106;
E a failure to file a certification of annual or interim filings required by MI 52-109 Certification of
Disclosure in Issuers Annual and Interim Filings;
F a failure to file required proxy materials or a required information circular or report in lieu
thereof;
G a failure to pay a fee required by the Act or the regulations;
H A continuous disclosure document. though filed on time. is deficient in one or more of the
following areas:

i. Financial statements of the issuer or the auditors report accompanying the financial
statements do not comply with the requirements of NI 51-102. NI 81-106 or NI 52-107
Acceptable Accounting Principles. Auditing Standards and Reporting Currency;
ii. The issuer has acknowledged that its financial statements or the auditors report
accompanying the financial statements may no longer be relied upon;
iii. The issuers AIF. MD&A. MRFP. information circular or business acquisition reports
do not contain information for each of the content items required by NI 51-102 or NI
81-106; or
iv. some other deficiency in the financial statements or in the issuers continuous disclosure
record is so significant as to constitute default;

I a failure to file an issuer profile supplement required by NI 55-102 System for Electronic
Disclosure by Insiders (SEDI);
J A failure to file material change reports required under section 75 of the Act. NI 51-102 or NI
81-106;
K A failure to update the Commission as required under subsection 75(4) of the Act. NI 51-102 or
NI 81-106 after filing a confidential report of a material change;
L a failure to file a business acquisition report required by NI 51-102 or NI 81-106;
M a failure to file a report on reserves data and other oil and gas information as required by NI 51-
101 Standards of Disclosure for Oil and Gas Activities or a technical report as required by NI
43-101 Standards of Disclosure for Mineral Projects;
Z default for Any Other Reason

Source: OSC website

41
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