Stock price contagion effects through investment banks

Abstract

ABSTRACT This paper investigates how stock market investors react to non-fraudulent firms that share the same investment bank with fraudulent companies. Using a Chinese sample from the period of 2003 to 2018, we find that firms penalized for IPO or M&A fraud induce stock price declines among non-fraudulent firms which share the same investment banks (non-fraudulent contagion firms). The results also show that stock price declines are more pronounced for low-quality investment banks, and investors impose larger penalties on stock prices when non-fraudulent client firms are of lower earnings quality, weaker corporate governance, and higher information asymmetry. Furthermore, we demonstrate that the non-fraudulent contagion firms are more likely to commit accounting fraud and exhibit inferior long-term post-IPO/post-M&A performance. Overall, the findings indicate an important stock price contagion effect occurring at the investment bank level.