The Good in Being Notoriously Bad: Repeated Acts of Corporate Illegality and Investor Reactions

Abstract

When news about a firm’s illegal behavior become public, investors face considerable difficulties in assessing the magnitude of its impact on the offender’s financial performance. Facing this opaque information environment, investors are likely to look for alternative informational cues. Research on organizational reputation and cognition suggests that a firm’s “criminal history” (i.e., the number of its prior illegal acts) may convey important information to investors about whether the focal allegation is warranted and whether the alleged illegal act is likely to remain a one-off event. Based on an in-depth analysis of illegal acts in the U.S. utilities industry over a 28-year time horizon, we find support for the proposition that a firm’s criminal history influences investor reactions to newly detected illegal acts. Investors penalize firms with no or a minor criminal history less severely. Interestingly, however, we also find that investors react less negatively to new illegal acts involving firms with extensive criminal histories than to new acts involving firms with moderate criminal histories. We further find that the pervasiveness of corporate illegality in the industry and prior firm acquittals alter the effect of recidivism on investor reactions. Collectively, our study thus answers recent calls to explore the role of recidivism in the context of corporate illegality and provides some evidence for positive side effects of a bad corporate reputation.