Is There Penalty for Crime: Corporate Scandal and Management Turnover in China

Abstract

Corporate fraud scandals have plagued the emerging markets such as China. This paper studies the cost to Chinese firms and their management for committing fraud. We find that the enforcement actions on firms with violation of securities laws from the regulation authorities are not severe. The stock price reactions to revelation of scandals are negative and statistically significant. We particularly examine the management turnover associated with the scandals. We find that fraud firms have higher management turnover than the matching non-fraud firms. However, we track down where the Chairman and CEO land after the turnover, and find a large portion of those leaving the fraud firms move to management positions in other firms and many of them actually even get promotion. Only a very small portion of CEOs and Chairmen receive legal or administrative penalty. We further find that Chairman and CEO with certain political background are less likely to receive legal or administrative penalties. We argue that the low effectiveness of law and lack of reputation mechanism on managerial labor market leads to the rampancy of corporate frauds and stagnancy of stock market development in China. Our findings provide direct evidence that legal system affects the stock market development.