What is Click Fraud?
Click Fraud is the process of clicking ads paid for by a competing advertiser in order to inflate his or her costs artificially. It is also the process of clicking AdSense ads on your own website in order to inflate your own AdSense income, again at the expense of the advertiser.
Aggressive advertisers sometimes click AdWords ads of competitors in order to use up their advertising budget on valueless traffic. This then leaves the agressive advertiser free to advertise without competition, a situation that can make his own clicks much cheaper. The risk is highest where competition is greatest and where individual clicks can cost tens of dollars.
The search engines aim to crack down on click fraud hard because if it became very widespread it would significantly reduce the willingness of advertisers to use PPC advertising such as AdWords.
AdSense click fraud is also monitored closely by Google and it is part of the Terms and Conditions of becoming an AdSense publisher that you agree never to click on ads on your own sites. To do would not only be silly, it would be immoral.
For serious PPC advertisers, reducing click fraud is an important part of AdWords Management and by monitoring the IP addresses of people who are clicking on your AdWords ads and visiting your site, something you can do readily with simply statistical packages like StatCounter, you can spot fraudulent activity and then block the relevant IP addresses from seeing your ads.