A selection of interesting articles we found recently about corporate fraud.
Good apples, bad apples among Chinese companies traded in the US
Committing financial fraud is a serious breach of business ethics. However, there are few large scale studies of financial fraud, which involve ethical considerations. In this study, we investigate the pervasive financial scandals, which by the end of 2012 involved more than a third of the US-listed Chinese companies. Based on a sample of 262 US-listed Chinese companies, James Ang and his team analyse factors that differentiate between firms that commit financial fraud and those that do not.
They find that firms more predisposed to unethical behaviour, due to their low regional social trust in the home country and low respect for regulations and laws as proxied by political connections, are more likely to commit accounting and financial fraud. Such firms take advantage of low hurdles for listing via reverse mergers and avoid third-party monitoring through poor governance and auditors. Finally, the researchers find evidence, after these scandals, of non-fraudulent firms differentiating themselves from the fraudulent firms by sending costly signals such as insiders purchasing shares, increasing dividends, and going private.
For more, see: James S. Ang, Zhiqian Jiang & Chaopeng Wu. 2016. Good Apples, Bad Apples: Sorting Among Chinese Companies Traded in the U.S.
Journal of Business Ethics, 134(4), 611-629.
How do firms punish executives in fraudulent firms in China?
This study investigates the relation between CEO compensation and corporate fraud in China. Martin Conyon and Lerong He document a significantly negative correlation between CEO compensation and corporate fraud using data on publicly traded firms between 2005 and 2010. Their findings are consistent with the hypothesis that firms penalise CEOs for fraud by lowering their pay.
The authors also find that CEO compensation is lower in firms that commit more severe frauds. Panel data fixed effects and propensity score methods are used to demonstrate these effects. Results also indicate that corporate governance mechanisms influence the magnitude of punishment. The researchers find that CEOs of privately controlled firms, firms that split the posts of CEO and chairman, and CEOs of firms located in developed regions suffer larger compensation penalties for committing financial fraud. Finally, they show that CEOs at firms that commit fraud are more likely to be replaced compared to those at non-fraud firms.
Read further at: Martin J. Conyon & Lerong He. 2016. Executive Compensation and Corporate Fraud in China.
Journal of Business Ethics, 134(4), 669-691.
Is it who you know? Institutional investors, political connections, and regulatory enforcement against corporate fraud
Wenfeng Wu and colleagues investigate two under-explored factors in mitigating the risk of corporate fraud and regulatory enforcement against fraud, namely institutional investors and political connections. The role of institutional investors in the effective monitoring of a firm’s management is well established in the literature. The researchers further observe that firms that have a large proportion of their shares held by institutional investors have a lower incidence of enforcement actions against corporate fraud. The importance of political connections for enterprises, whether in a developed market such as the United States or an emerging market such as China, has been established by previous studies.
However, the authors also find evidence of another positive effect of political connections: they may reduce the incidence of enforcement action against corporate fraud. The researchers also find that political connections play a more significant role in reducing regulatory enforcement incidents against non-state-owned enterprises and firms in weaker legal environments, whereas institutional ownership plays a more important role in reducing regulatory enforcement incidents against state-owned enterprises.
More details are at: Wenfeng Wu, Sofia A. Johan & Oliver M. Rui. 2016. Institutional Investors, Political Connections, and the Incidence of Regulatory Enforcement Against Corporate Fraud.
Journal of Business Ethics, 134(4), 709-726.
Does external monitoring by financial analysts deter corporate fraud in China?
Jiandong Chen’s research team examines whether analyst coverage influences corporate fraud in China. The fraud triangle specifies three main factors, i.e. opportunity, incentive, and rationalisation. On the one hand, analysts may reduce the fraud opportunity factor through external monitoring aimed at discouraging managerial misconduct, which can moderate agency problems. On the other hand, analysts may increase the fraud incentive factor by pressurizing managers to achieve short-term performance targets, which can exacerbate agency problem.
In either case, the potential influence of analysts on the fraud rationalisation factor may be more pronounced among firms that are more dependent on the capital market for corporate finance. Using a sample of Chinese listed firms, Chen et al. show a negative association between corporate fraud propensity and analyst coverage, and that this effect is more pronounced among non-state-owned enterprises, which are more reliant on the stock market for external funding.
These findings suggest that analyst coverage contributes to corporate fraud deterrence in emerging economies characterised by weak investor protection. The main policy implication is that further development of the analyst profession in emerging economies may benefit investors and strengthen business ethics.
Find more detail in: Jiandong Chen, Douglas Cumming, Wenxuan Hou & Edward Lee. 2016. Does the External Monitoring Effect of Financial Analysts Deter Corporate Fraud in China?
Journal of Business Ethics, 134(4), 727-742.
Ownership structure and insider trading
In this paper, the authors examine the information content of insider transactions in China and analyse how ownership structures shape market reaction to these transactions. They find that the cumulative abnormal return (CAR) to insider purchases is a convex function of the percentage of shares owned by the largest shareholder. Further, the CAR to insider purchases is lower when the largest shareholder is government-related, or when the control rights of the largest shareholder exceed its cash flow rights.
Qing He and Oliver Rui also find that the market reaction to insider purchases is more positive for firms audited by Big4 auditors. However, they do not find a significant relationship between an ownership structure and the market reaction to insider sales. These results are remarkably robust to alternative model specifications, corporate insider identities, and recent corporate news releases on price-sensitive events. Finally, He and Rui show that market reaction to insider purchases is larger for firms with less severe expropriations, as captured by the use of other receivables.
Read more at: Qing He& Oliver M. Rui. 2016. Ownership Structure and Insider Trading: Evidence from China.
Journal of Business Ethics, 134(4), 553-574.