Consequences of fraud and overcoming negative market reaction

Abstract

We examine the market reaction to a sample of firms following the announcement of the firms' involvement in fraud, referred to as the trigger event. We find that these firms experience negative and significant returns following the announcement of fraud, in contrast to a control sample. More importantly, we examine tactics, such as changes in executives, auditing firm, and company name, that these firms may use to regain the market's confidence. We find that the market reacts negatively right after the change in executives, but the negative trend is reversed in the long-term for firms that make an executive change quickly after the trigger event. Similarly, firms that quickly change their auditing firm fare better. We also find that there is significantly more information asymmetry during the trigger event and at the litigation date, as well as during changes in CEO, CFO, and auditor. We find a prompt change in CFO is positively and significantly related to, and therefore predicts, better long-term stock performance.