| The law and economics literature argues that markets constrain fraud. Professor Fischel and Judge Easterbrook concede that some firms defraud by camouflaging themselves as honest firms. However, they conclude that focusing on CEOs who wish to engage in fraud is misleading because it fails to take into account the actions of honest firms. Honest firms have an incentive to differentiate themselves from frauds and Easterbrook and Fischel state that they do so successfully, e.g., by hiring "Big Five" accounting firms. The authors assume that the reputational interest of such audit firms will cause them to refuse to aid frauds. They argue that creditors and shareholders are adept at reading such signals and avoiding the fraudulent. This is in contrast to regulators, who fail to differentiate honest CEOs (Fischel puts Michael Milken in this category) from the fraudulent. I present the facts of Fischel's attempt to apply this theory in the real world in which he argued that the regulators' criticisms of Lincoln Savings were invalid. The case illustrates the ability of CEOs engaged in control fraud to counter honest firm's efforts at differentiation by manipulating top audit firms, and other professionals, to assit the fraud. |
Updated 05/20/2006