Abstract
Corporate misconduct research has observed negative market reactions following misconduct. Drawing on signaling theory, this study considers misconduct as a negative signal and links misconduct severity to market reactions. We argue that severity level decides signal strength and increases market reaction magnitude. However, it is unclear why different firms are punished to varying degrees for similar misconduct. We therefore demonstrate how perceptual biases distort investors’ perceived severity and describe how the effect of severity is moderated by firm reputational signals, including moral, technical, and leadership capital. This study is supported by an empirical analysis of 344 Chinese listed firms that engaged in financial misconduct during 2009–2019. Accordingly, we facilitate a more fine-grained understanding of the relationship between corporate misconduct and market reactions.
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