How should corporate mismanagement or fraud be taken into account in assessing the risk of investments?

Asked on by stavia03

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thanatassa | College Teacher | (Level 1) Distinguished Educator

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Mismanagement and fraud are among the major risks in certain types of investing. As recent scandals, such as the Enron collapse and the ongoing LIBOR-fixing affair, demonstrate, certain types of unethical or fraudulent behaviour can occur anywhere. That being said, fraud and other forms of corporate malfeasance are generally lower in countries with strong regulatory frameworks and lower in publicly traded companies which are more highly regulated than smaller, privately held companies. Many of the emerging markets which offer the highest rate of return also can be the most prone to fraud. On the other hand, this is a basic principle of investing -- that rate of return in proportional to risk. To estimate risk, you can look at transparency and similar indices to identify the statistical probabilities of risk of fraud by market segment and geographical area, and, of course, the more research you do on the individual company and its business environment the better you will be able to quantify risk.

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