Academic journal article Academy of Accounting and Financial Studies Journal

Management Fraud and Stock Price Performance

Academic journal article Academy of Accounting and Financial Studies Journal

Management Fraud and Stock Price Performance

Article excerpt


Corporate scandals as measured by accounting irregularities and other misdealings by management have been pervasive in recent years. Such irregularities, however, are not new. We collect a sample of companies that have been the subject of an Securities and Exchange Commission enforcement release and investigate wether the stocks of these companies are long-term good investments. Specifically, we examine the three year period after the enforcement release and find that our sample has a much lower survival rate than an industry-matched group of firms. Further, in the one year period subsequent to the enforcement release, our sample of firms experience negative returns. Interestingly, however, our group of matched firms perform (statistically) as poorly as the "fraud" firms in the year after the enforcement release. This is consistent with contagion effects in industries where one firm is accused of fraudulent activities.


Recent corporate scandals at companies such as Enron, WorldCom, and Tyco (among others) have brought to light the potentially devastating impact of management misbehavior on shareholder wealth. Although these recent scandals have increased the focus on accounting irregularities and improper actions by management, instances of corporate improprieties have a long history. In general shareholders have suffered upon the revelation of these improprieties. Nourayi (1994) and Feroz, et al. (1991) find significant average abnormal returns of 13% to 33% upon announcements of SEC enforcement actions involving potential management misdealings.

While it is generally accepted that illegal and/or improper corporate actions result in immediate losses to shareholders, the long-term impact on shareholder wealth remains unclear. Debondt and Thaler (1985), Brown, et al. (1988), Atkins and Dyl (1990), Bremer and Sweeny (1990), Akbigbe, et al. (1998) and Li (1998) all find evidence that market participants overreact to negative news announcements and confirm subsequent short-term price reversals to account for these overreactions. Investors are likely to overreact to management fraud as well. Indications of management fraud, however, typically lead to greater uncertainty for investors over a longer horizon than the shorter-term reversals found by Debondt and Thaler (1985) and others. Thus, we examine a longer time period in order to determine whether the short-term reaction to revelations of corporate fraud are the result of an overreaction to negative information by market participants. If investors systematically overreact to revelations of management fraud in the short-term, stocks of these companies may generate longer-term excess returns.

In particular, we examine the long-term buy and hold returns of companies that are the subject of an SEC enforcement release. We focus on the Securities Exchange Commission Act of 1934 section 10(b) enforcements, which are indicative of management fraud. If investors overreact as in DeBondt and Thaler (1985), purchasing the stock of a company which is being subjected to an SEC investigation could generate excess returns. On the other hand, if markets are indeed weak form efficient, such "purchasing opportunities" are unlikely to generate superior returns.


For our study we require a sample of companies with known fraudulent financial statements. The Securities Acts of 1933 and 1934 were passed with two main objectives: (1) to provide investors with material financial and other information concerning securities offered for public sale, and (2) to prohibit misrepresentation, deceit, and other fraudulent acts and practices. Because the government delegates enforcement powers concerning management fraud to the SEC, we use the SEC enforcement releases to collect our sample of companies with fraudulent financial statements.

An issue with our use of SEC enforcement releases is the assumption of the guilt of the companies in the SEC enforcement. …

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