Fraud and Firm Performance: Evidence from Fraud on the Market and Securities Class Action Lawsuits

61 Pages Posted: 3 May 2010 Last revised: 12 Jun 2010

See all articles by Christopher B. Malone

Christopher B. Malone

School of Economics and Finance, Massey University

John D. Finnerty

Finnerty Economic Consulting LLC; Fordham University - Finance Area

Shantaram P. Hegde

University of Connecticut - School of Business

Date Written: May 1, 2010

Abstract

We investigate the argument that securities frauds are preceded by surprisingly good firm performance but are followed by rapid negative investor response by studying the long-term stock performance of a sample of 430 firms that disclosed securities fraud and experienced class action lawsuits filed between 1989 and 1999. Estimating Fama-French (F-F) three-factor model-based monthly abnormal returns for three events, alleged fraud commission (FC), fraud disclosure (FD), and initial class action filing (CA), we find significant upward price drift during the five-year pre-FC horizon and weak evidence of a negative drift for up to five years following CA. The observed pre- and post-event abnormal returns cannot be explained by changes in systematic risk (F-F factor loadings), suggesting that the effects of fraud are confined primarily to changes in expected cash flows rather than changes in discount rates. Further, we find positive abnormal trading volume and return volatility during the pre-FC horizon but a significant deterioration in market quality, as evidenced by a persistent negative abnormal drift in relative trading volume and a sustained increase in return volatility, for up to five years following CA.

JEL Classification: G12, G14, G18

Suggested Citation

Malone, Christopher B. and Finnerty, John D. and Hegde, Shantaram P., Fraud and Firm Performance: Evidence from Fraud on the Market and Securities Class Action Lawsuits (May 1, 2010). Australian Centre for Financial Studies - Finsia Banking and Finance Conference 2010. Available at SSRN: https://ssrn.com/abstract=1598783 or http://dx.doi.org/10.2139/ssrn.1598783

Christopher B. Malone

School of Economics and Finance, Massey University ( email )

Private Bag 11-222
Palmerston North, 30974
New Zealand

John D. Finnerty

Finnerty Economic Consulting LLC ( email )

60 East 42nd Street
Suite 2910
New York, NY 10165
United States
2125991640 (Phone)
2125991242 (Fax)

HOME PAGE: http://www.finnecon.com

Fordham University - Finance Area ( email )

113 West 60th Street
New York, NY 10023
United States
2125991640 (Phone)
2125991242 (Fax)

HOME PAGE: http://www.finnecon.com

Shantaram P. Hegde (Contact Author)

University of Connecticut - School of Business ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States
860-486-5135 (Phone)

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