Facing Turbulences with Organizational Slacks in a Corporate Scandal: Firm Value and Risks

Abstract

Corporate scandals happen not only when firms and managers deliberately commit fraud and harm the environment but also when firms have to recall malfunctioning products. Corporate scandals are more frequent than ever. Since information can be accessed easily and spread instantly, local issues quickly become global corporate scandals, which increases their strength and decreases the time for firms to implement a recovery plan. Corporate scandals bring uncertainty to the future of the firm’s financial health. Thus, they decrease expectations for returns and increase volatility of future cash-flows. Organizational slacks are resources detained by a firm to face an unexpected event. We believe they serve as a buffer in a situation of corporate scandal. Our study aims to determine the buffering role of organizational slacks can generate, when a corporate scandal hits a firm. To measure it, we use the event study methodology. We perform both short-term and long-term event study analyses. The former is based on a sample of 362 North American listed firms regarding 1,940 corporate scandals, from 2007 to 2018, and it measures the difference between the normal stock returns of the firms and the stock returns happening on the days surrounding the corporate scandal. The latter is based on 333 North American listed firms regarding 1,719 corporate scandals, from 2007 to 2018, and it determines the fluctuations of the idiosyncratic risk in a period of 252 days following the corporate scandal. Our findings reveal key insights into the role of organizational slacks in a corporate scandal situation. Moreover, we analyze the buffering effect of organizational slacks in an unstable environment by introducing the moderating role of market turbulence. Results show that: (1) a corporate scandal has a negative impact on the firm value and firm volatility; (2) organizational slacks have a positive impact on the scandal’s negative effect on the firm value and firm volatility; (3) and, detaining organizational slacks increases the negative effect of the corporate scandal on the firm value in a turbulent market environment, but mitigates firm volatility in the same environmental conditions. Our primary contribution is to the management-finance literature, in the way that we integrate research on organizational slacks and corporate scandal literature with frequent changes in fit between market and management decisions. Our second contribution is to managers, as we bring novel insights into the ways of mitigating the negative effect of a corporate scandal with organizational slacks.