Does the External Monitoring Effect of Financial Analysts Deter Corporate Fraud in China?

39 Pages Posted: 29 Jun 2011 Last revised: 16 Mar 2014

See all articles by Jiandong Chen

Jiandong Chen

Southwestern University of Finance and Economics

Douglas J. Cumming

Florida Atlantic University

Wenxuan Hou

University of Edinburgh - Business School; Shanghai Lixin University of Accounting and Finance

Edward Lee

University of Manchester - Alliance Manchester Business School

Date Written: January 1, 2014

Abstract

We examine whether analyst coverage influences corporate fraud in China. The fraud triangle specifies three main factors, i.e. opportunity, incentive, and rationalization. On the one hand, analysts may reduce the fraud opportunity factor through external monitoring aimed at discouraging managerial misconduct, which can moderate agency problems. On the other hand, analysts may increase the fraud incentive factor by pressurizing managers to achieve short-term performance targets, which can exacerbate agency problem. In either case, the potential influence of analysts on the fraud rationalization factor may be more pronounced among firms that are more dependent on the capital market for corporate finance. Using a sample of Chinese listed firms, we show a negative association between corporate fraud propensity and analyst coverage, and that this effect is more pronounced among non-state-owned enterprises (NSOEs), which are more reliant on the stock market for external funding. These findings suggest that analyst coverage contributes to corporate fraud deterrence in emerging economies characterized by weak investor protection. The main policy implication is that further development of the analyst profession in emerging economies may benefit investors and strengthen business ethics.

Keywords: fraud triangle; corporate fraud; agency problem; analyst coverage; China

JEL Classification: G32, P37

Suggested Citation

Chen, Jiandong and Cumming, Douglas J. and Hou, Wenxuan and Lee, Edward, Does the External Monitoring Effect of Financial Analysts Deter Corporate Fraud in China? (January 1, 2014). Journal of Business Ethics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1874114 or http://dx.doi.org/10.2139/ssrn.1874114

Jiandong Chen

Southwestern University of Finance and Economics ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

HOME PAGE: http://cjd.weebly.com

Douglas J. Cumming (Contact Author)

Florida Atlantic University ( email )

777 Glades Rd
Boca Raton, FL 33431
United States

HOME PAGE: http://booksite.elsevier.com/9780124095373/

Wenxuan Hou

University of Edinburgh - Business School ( email )

University of Edinburgh
29 Buccleuch Place
Edinburgh, Scotland EH8 9JS
United Kingdom

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

Shanghai Lixin University of Accounting and Finance ( email )

Edward Lee

University of Manchester - Alliance Manchester Business School ( email )

Booth St. West (Crawford House)
Manchester, M15 6PB
United Kingdom

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