Punish One, Teach A Hundred: The Sobering Effect of Peer Punishment on the Unpunished

Abstract

Direct experience of a peer’s punishment might have a sobering effect above and beyond deterrence (information about punishments). We test this mechanism in China studying the reactions to listed state-owned enterprises’ (SOEs) punishments for fraudulent loan guarantees by firms in the same location or industry (peers) and non-peer firms, across SOEs and non-SOEs. After experiencing SOEs’ punishments, peer SOEs cut their loan guarantees by more than non-peer SOEs and peer non-SOEs, even if information is common to all firms. The reaction is stronger for peer SOEs whose CEOs have higher career concerns or face lower costs of cutting guarantees. Managers’ overreaction to the salience of a peer’s punishment could be an important channel of transmission of the spillover effects of punishments on firms’ outcomes.

Keywords: Corporate Governance, Cultural Finance, Information Transmission, Peer Effects, Reputational Sanctions, Related Party Transactions, Emerging Markets, Corporate Fraud, Government Ownership.

JEL Classification: D91, D72, G32, G41, K42