Fraud, Market Reaction, and Role of Institutional Investors in Chinese Listed Firms

Abstract

We examine the extent and type of financial fraud committed by listed firms in China, stock market reaction to the detection and announcement of fraud, the characteristics of firms committing fraud, and the association between institutional ownership and financial fraud. One of our objectives is to study the monitoring role of different types of institutional investors, such as mutual funds, pension funds and insurance companies. Using fraud data from the Chinese Securities Regulatory Commission between 2001 and 2011, we find wide occurrences of fraud and a strong negative market reaction on the announcement date, particularly in cases of serious fraud. Fraud is more likely to take place at firms that have a smaller proportion of independent directors and at poorly performing firms. We find firms with higher mutual fund ownership subsequently have fewer incidences of fraud. We do not find any association between ownership by grey financial institutions, such as insurance companies and pension funds that are likely to have business ties with firms, and future corporate fraud. Our results are consistent with the hypothesis that ownership by independent