Corporate Fraud, External Debt and Corporate Cash Policy

Abstract

This paper explores the financial implications of corporate fraud by examining the impacts of corporate fraud on fraudulent firms’ external financing cost and internal cash holdings. Using a sample consist of 184 fraudulent firms that experience material litigation in securities class action, we find that firms’ cost of debt significantly increases associated with corporate fraud incident. In response to the costly external finance, fraudulent firms retain more cash to better cope with adverse shocks. Consistent with the precautionary motive argument, the value of cash increases after corporate fraud. In addition, corporate fraud contributes to financial constraints in the sense that fraudulent firms display a positive cash flow sensitivity of cash after corporate fraud. Our result indicates that corporate fraud can have a real impact on corporate outcomes by affecting the external financing cost and internal cash holdings.