Reactivity and Passivity After Enforcement Actions: Better Late Than Never Shujun Ding Chunxin Jia Yuanshun Li Zhenyu Wu ABSTRACT. We examine the dynamics between enforcement actions and the responses from both the board of directors and supervisory boards amid China’s governance reform. Rather than examining determinants of fraudulent activities, we investigate, after enforcement actions are imposed, whether the board of directors and supervisory boards react differently, and whether their different reactions play a role in preventing future occurrences of frauds. We find that both boards react to enforcement actions, but only the responses from the board of directors help us curb future enforcements under certain circumstances. The supervisory board fails to play any role in preventing future enforcements, even though it is one of the two monitoring mechanisms in the listed companies. Policy implications are discussed. KEY WORDS: corporate governance, enforcement actions, fraud, dual-board structure Introduction Fraudulent activities by publicly listed firms normally involve the violations of either capital market reg- ulations or accounting principles. Examples of these fraudulent activities include, but are not limited to, share price manipulations by means of a ‘‘pump-and- dump’’ approach, the delay of accounting reports, inaccurate revenues and expenses figures through fictitious transactions, and the expropriation of minority shareholder interests. These fraudulent activities not only damage individual investors’ interests but also undermine the integrity of the entire capital market mechanism. Siebert (2007), for instance, claims that fraudulent activities in the U.S. capital market resulted in a loss of over USD 7 trillion in the first 3 years of the twenty-first century. Emerging markets are not immune to fraudulent activities; rather, a widespread fraud could be found in emerging markets, possibly due to a less-devel- oped macro governance environment (Li et al., 2006). For instance, between 2001 and 2006, 362 enforcement actions on the Chinese stock markets were imposed by capital market regulators, the Chinese Securities Regulatory Commission (CSRC), and/or by the stock exchanges because of fraudulent activities (Jia et al., 2009). Furthermore, it is indicated that some firms engage in fraudulent activities repeatedly. To safeguard investor’s interests by mitigating the impairment arising from fraudulent activities, listed companies are expected to take actions to respond to the enforcements efficiently and effectively, and prevent future frauds. However, observations of repeated frauds in China seem to suggest the contrary. Our study is intended to examine how corporate governance mechanisms react to enforcement actions, and whether their responses, if any, are able to eliminate frauds in the periods thereafter. Since it is very hard to discover all the frauds committed by the listed companies due to the informational asymmetry between their investors and management teams, we follow previous studies (e.g., Chen et al., 2006; Dechow et al., 1996; Jia et al., 2009) to utilize enforcement actions as proxies for fraudulent activities. In the corporate governance literature, few studies have examined the dynamic relationship between fraudulent activities and the subsequent reactions of corporate governance mechanisms. Beasley (1996) and Dechow et al. (1996) find that the involvement of independent board members and the separation of CEO and board chair duties can reduce the inci- dence of fraud. Chen et al. (2006) find that the Journal of Business Ethics (2010) 95:337–359 Ó Springer 2011 DOI 10.1007/s10551-011-0849-2 123 221 Reprinted from the journal